Equity Premium and the Monetary Policy

Abstract

The impact of the monetary policy, especially the impact of the forward-looking Taylor rules on the equity risk premium from the perspective of investor’ risk perception was examined for the United States. This is done by using three forward-looking Taylor rules as well as the Fama-French five factors model. In addition, the impacts of federal funds rates before and after the financial crisis in 2008 are compared. This study adds to the literature by exploring the relationship between equity premium and the monetary policy with the usage of four variables from the Fama-French five factors model. The results show that a significant and negative relationship is observed between the monetary policy and excess return on equity. Moreover, the impact of federal funds rates is higher during the post-crisis period. Keywords: the Taylor rule, the equity premium, Fama-French five factors model