Does the Stock Market Under-React to the Federal Reserve Bank's Monetary Policy Actions?

This paper analyzes the reaction of the stock market to the monetary policy actions of the Federal Reserve (the Fed). Specifically, we examine the reaction of the stock market to the monetary policy announcements by the Federal Open Market Committee (FOMC) of the Fed. We show that the full information conveyed by the Fed is not immediately incorporated in asset prices and that there is a statistically significant abnormal return to a broad market index on the day after the announcement by the FOMC of its monetary policy actions. We use data from the federal funds futures market to measure the expected and unexpected changes in the federal funds rate. We demonstrate that the market reacts to the unexpected changes in monetary policy of the FOMC. We detect positive and statistically significant abnormal market returns on the day after the FOMC makes its monetary policy announcements. We reject the hypothesis that these returns are unpredictable by finding predictable returns the day following the day of the FOMC announcement of its monetary policy actions