Monetary policy surprises have an immediate impact on markets. There are several channels through which a monetary policy shock will work. One that has not been deeply explored is the risk-taking channel. This is related to the impact of monetary policy on risk appetite and risk-taking. A monetary shock will have an impact on risk appetite based on the expected forward implication of future rates as well as the uncertain cash flow effects from a higher discount rate. A new study "Risk Appetite and the Risk-Taking Channel of Monetary Policy" looks at the specific impact of monetary tightening surprises on risky assets. A subset of the assets studied is included in the figure below.
The data show that there is a clear post announcement drift from a monetary policy surprise with risky assets. Given the impact on risky assets are highly correlated, one can argue that risk appetite has declined with a monetary tightening. The effect is not on one day but will stretch through time.
Monetary policy may work in mysterious ways. However, we can say that there are different paths through which monetary policy impacts markets: the neoclassical, credit, and risk-taking channels. All impacts may not be the same. To understand the impact of monetary policy on financial markets, it is critical to work through the implications of each channel to reduce the mystery.
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