The portfolio balance channel: an analysis on the impact of quantitative easing on the US stock market

This paper provides empirical evidence on the pass-through of quantitative easing (QE) on equity returns in the United States (US). The methodology mimics the programme’s impact on investors’ required returns for financial assets through the QE portfolio balance channel. This analysis of monetary policy involves using a VAR model, simulating a reduction in the share of sovereign bonds as part of central bank purchases. The findings suggest that QE caused a significant reduction in the equity risk premium (ERP) for the S&P 500. This equates to an increase in equity prices of 9.6% and acts as evidence for an active portfolio rebalancing of private sector individuals into risky assets following QE. The findings of the paper also suggest that the impact of a monetary policy expansion results in varying effects, while an expansionary policy has a stronger positive effect on equity prices with QE than without. Furthermore, we test for the presence of structural breaks in the VAR model. Firstly, using a multiple structural breaks approach, we find evidence of regime shifts and secondly accounting for the shifts in the conditional mean leads to similar conclusions as found earlier.