Monetary Policy, Intermediaries, and Asset Prices

The global financial crisis of 2008 has made the central role of intermediaries, such as banks, credit unions, pension funds or insurance companies for financial markets particularly visible. Monetary policy, a central bank`s toolbox to maintain price stability, in turn can affect the behavior of intermediaries in important ways that matter for the functioning of markets as a whole. These insights, combined with existing research on the link between intermediaries and asset prices motivate us to explore the interplay of financial intermediaries, monetary policy and asset prices. Previous research has shown that asset prices, in particular interest rates, respond to monetary policy. The literature typically considers unexpected responses to monetary policy so called monetary policy surprises or shocks. Yet, key questions of why and how monetary policy matters remain, by and large, unanswered. Put differently, (i) what exactly is it that takes markets by surprise? And (ii) how does the transmission to asset prices work precisely? By answering questions (i) and (ii), our goal is to identify the so-called intermediary channel of monetary policy. For our analysis, we distinguish monetary policy shocks due to policy actions, that is responses in asset prices around announcements of policy decisions, and shocks due to policy communication, that is market responses during press conferences or similar events without news about an actual policy decision. Our strategy relies on an economic interpretation of communication shocks. To answer the first question, i.e. what is it that takes markets by surprise, we will use textual analysis of monetary policy transcripts to compile a dictionary of central bank communication that associates topics discussed with keywords and common expressions used by central banks and allows for a quantification of their textual features. Next, we want to analyze the extent to which conventional measures of monetary policy shocks can be understood through the lens of our dictionary. For example, in a preliminary analysis for the ECB, we find that conventional MP shocks measured from interest rates can be understood - economically - as the ECB president adjusting her tone on the topic `economic activity, whereas other topics matter much less. Using the insights gained from the textual analysis exercise, we then proceed with the identification of an intermediary channel of monetary policy. More specifically, we want to use our dictionary to identify communication that is specifically relevant from the vantage point of intermediary asset pricing theory. We want to estimate communication shocks based on market variables that should be particularly relevant for financial intermediaries. We can then use (i) and (ii) to pin down the intermediary channel via an identification scheme to make differences within asset classes as well as in the cross-section of asset classes visible. The expected outcomes of this project will contribute to the asset pricing literature, in particular to the growing streams which focus on monetary policy, the role of financial intermediaries, or their interaction.