Equity Markets and Monetary Policy Surprises

Mayank Gupta, Amit Pawar, Satyam Kumar,

Abhinandan Borad and Subrat Kumar Seet1

Abstract

The paper examines the impact of monetary policy announcements on stock returns
and volatility in equity prices in India. It decomposes changes in Overnight Indexed
Swap (OIS) rates on policy announcement days into target and path factors. The
target factor captures the surprise component in central bank policy rate action,
while the path factor captures the impact of central bank communication on market
expectations regarding the future path of monetary policy. The empirical analysis
using daily data suggests that equity returns on policy announcement days are
impacted only by the path factor (i.e., market’s expectations of future monetary
policy trajectory), while both target and path factors (both of which capture the
unanticipated component of monetary policy) impact the volatility in equity prices.
An event study analysis undertaken by constructing short duration windows around
the monetary policy announcements using intraday data also indicates that the path
factor helps explain changes in equity returns.
JEL Classification: C38, E52, E58

Keywords: Equity markets, monetary policy communication, principal component

analysis

1
This research paper is prepared by Mayank Gupta, Amit Pawar (amitp@rbi.org.in), Satyam Kumar, Abhinandan
Borad and Subrat Kumar Seet from Department of Economic and Policy Research, Reserve Bank of India. The
authors are grateful to Sanjay Kumar Hansda, Adviser for his continuous encouragement and guidance to
undertake this research project. The authors are thankful to Anand Prakash, Indranil Bhattacharyya, Akanksha
Handa and other seminar participants at the DEPR Study Circle, and an anonymous referee for their
comments/suggestions. The views expressed in this paper are those of the authors and do not represent the views
of the Reserve Bank of India.