A long-standing body of research, inspired by Bernanke and Kuttner (2005), has documented the effects of Fed interest rate surprises on stock markets. While stock markets provide valuable information about the investor risk premium and dividend growth expectations, researchers have only recently developed more comprehensive tools to estimate the term structure of equity risk premia and dividend growth expectations across a broad range of maturities. In this post, we investigate the impact of monetary policy surprises (or shocks) on short- and long-term estimates of risk premia and growth expectations through the lens of the Giglio, Kelly, and Kozak (2024) model.
Pinning Down Monetary Policy Shocks
Measuring monetary policy shocks is challenging, but most current frameworks rely on the high-frequency identification approach of Kuttner (2003) and Bernanke and Kuttner (2005). At their core, monetary policy surprises (MPS) are constructed by examining price changes in interest rate-linked futures contracts within a narrow window around FOMC announcements. Positive (negative) MPS values correspond to hawkish (dovish) policy surprises. The Federal Reserve Bank of San Francisco’s Monetary Policy Surprise dataset extracts these shocks from different maturity Eurodollar futures and aggregates them into a monthly series. The chart below displays the dynamics of these shocks over the last three decades.
Time Series of Monetary Policy Surprises
Since the series represents surprises relative to prevailing interest rate expectations it does not necessarily align with broader economic cycles, except at the onsets of economic business cycles. The average value of the surprises in the sample is close to zero, with a slight negative mean in NBER recessions and slight positive mean otherwise. For simplicity, we classify economic episodes into three subsamples: periods with positive MPS (hawkish surprises), negative MPS (dovish surprises), and no change (no FOMC meeting). This allows us to test whether the news per se or its directional change is associated with movements in risk premia.
Connection with Equity Term Structure
While the MPS mechanically move the term structure of government bond interest rates, that is not the only channel driving asset prices. Equity risk premia and dividend growth expectations are two fundamental inputs in present value calculations, yet they are difficult to disentangle using stock prices alone. This is particularly true when considering the entire term structure of risk premia and growth expectations, which summarize the expected path of these variables across maturities, analogous to the term structure of interest rates. To illustrate the relationship between these components, one can express the value of a stock or index as the discounted present value of future dividends:
where denotes expected future dividends embedding growth rate expectations, is the market value of a stock or index, and is the -maturity zero-coupon discount rate. While it is customary to assume that the discount rate is constant across maturities, economic models (such as habit formation and long-run risk) suggest that investors dislike long-duration cash flows more than short-duration cash flows because of their greater exposure to risk and uncertainty. More generally, the discount rate therefore can be decomposed into a risk-free rate () component and a maturity-matched risk premium ():
The object of this post is to investigate how the entire term structure of risk premia and expected growth rates respond to different monetary policy shocks.
Measuring Risk Premia
We leverage the recent model of Giglio, Kelly, and Kozak (2024), which allows us to disentangle risk premia and dividend growth rates (in excess the of risk-free rate). The model estimates risk parameters by fitting the cross-sectional and time-series dynamics of stock market and fifty-one anomaly portfolio returns over the 1973-2020 period. The paper seeks to identify risk factors (principal components of anomaly returns and their valuation ratios) that drive investors’ expectations of the future evolution of stock prices. The estimation produces monthly series of dividend growth rates and risk premia for a wide range of maturities.
The full sample (1988-2020) estimates of risk premia and dividend growth rates are plotted in the chart below. As we can see, expected dividend growth rates are relatively stable at around three percent. This is intuitive since short-term dividend growth rates should, over time, converge toward the long-run growth rate if expectations are internally consistent and the sample is well-balanced. More interesting insights emerge from the term structure of risk premia. In line with classical asset pricing models, the term structure is upward sloping, starting slightly negative for the shortest maturities and converging towards 3.6 percent at the fifteen-year horizon. The term structure indicates that investors dislike long-term risk and hence apply substantially higher risk premia when discounting long-term equity cash flows.
Upward Sloping Term Structure of Risk Premia
Are Monetary Policy Shocks Good or Bad News?
The monetary policy information channel is one of the leading hypotheses used to explain stock market reactions to monetary policy surprises. All else equal, one might expect that sudden cuts in interest rates signal private information about a weakening economy, which should in turn affect both risk premia and expected dividend growth rates. To test this idea, we estimate the average term structure across different MPS subsamples (charts below).
Based on the estimates, there is some support for the information channel of MPS. Negative surprises are associated with, on average, a 25-basis-point increase in the average risk premium. This effect is uniform across different maturities and indicates a parallel upward shift in the level of the risk premium. On the other hand, we observe similar movements following positive monetary policy surprises, potentially suggesting that rapid rate hikes often signal similar bad news about the economy (for instance, supply side inflationary pressures). The effects of both negative and positive surprises are not very large in economic magnitude and are statistically insignificant, but this may be explained by the fact that, at most FOMC meetings, these surprises are very small.
Lastly, expected dividend growth rates appear to co-move only with dovish surprises. There is an over 50-basis-point drop for the shortest maturities and a 20-basis-point decrease for the longest maturities. This is an intuitive result, given that large rate cuts typically occur around the onset of economic distress and therefore signal deteriorating growth prospects. Interestingly, the same pattern is not observed for hawkish surprises. This may suggest that interest rate hikes often reflect strong demand conditions or inflationary pressures, which do not necessarily reduce nominal economic growth.
Monetary Policy Shocks Have a Small Impact on Risk Premia
Negative Monetary Policy Shocks Lower Expected Dividend Growth Rates
Conclusions
Estimation of the equity term structure and its interplay with monetary policy remains an active and important area of research. In this post, we extend a recent model of Giglio et al. (2024) and investigate the effects of FOMC monetary policy surprises on equity risk premia and dividend growth expectation across a wide range of maturities. Our findings suggest that large interest rate shocks induce a parallel increase in the level of equity risk premium. On the other hand, only negative monetary policy surprises lower dividend growth expectations.
Henry Dyer, a former research analyst in the Federal Reserve Bank of New York’s Research and Statistics Group, is pursuing a master’s in finance at the MIT Sloan School of Management.
Tomas Jankauskas is a financial research economist in the Federal Reserve Bank of New York’s Research and Statistics Group.
How to cite this post:
Henry Dyer and Tomas Jankauskas, “Does the Equity Term Structure Respond to Monetary Policy Shocks? ,” Federal Reserve Bank of New York Liberty Street Economics, August 12, 2026, https://doi.org/10.59576/lse.20260812
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Disclaimer
The views expressed in this post are those of the author(s) and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the author(s).
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Facts Only
* Henry Dyer and Tomas Jankauskas authored the research.
* The research was published by the Federal Reserve Bank of New York on August 12, 2026.
* The study utilizes a model developed by Giglio, Kelly, and Kozak (2024).
* Data includes stock market and fifty-one anomaly portfolio returns from 1973-2020.
* Monetary policy surprises (MPS) are measured using price changes in interest rate-linked futures contracts around FOMC announcements.
* The Federal Reserve Bank of San Francisco provided the Monetary Policy Surprise dataset.
* The full sample for risk premia and dividend growth estimates covers 1988-2020.
* Expected dividend growth rates remained relatively stable at approximately three percent.
* The risk premia term structure is upward sloping, converging toward 3.6 percent at a fifteen-year horizon.
* Negative MPS are associated with an average risk premium increase of 25 basis points.
* Negative MPS are associated with a dividend growth rate decrease of over 50 basis points for short maturities and 20 basis points for long maturities.
Executive Summary
Monetary policy surprises—defined as interest rate movements that deviate from market expectations—influence the equity term structure through both risk premia and dividend growth expectations. Using a model that disentangles these two components, evidence suggests that both hawkish and dovish surprises can lead to a parallel increase in the level of equity risk premia, though these effects are statistically insignificant and small in economic magnitude.
A more distinct relationship exists between dovish surprises and growth expectations. Large rate cuts often coincide with economic distress, signaling a deterioration in future dividend growth prospects; this manifests as a significant drop in expected growth rates, particularly for shorter maturities. Conversely, hawkish surprises do not show a similar negative impact on growth expectations, likely because rate hikes often reflect strong demand or inflationary pressures rather than economic contraction. While these findings provide some support for the monetary policy information channel, the overall impact of most FOMC surprises on risk premia remains limited.
Full Take
This research employs a sophisticated econometric approach to solve a classic problem in finance: the inability to separate risk aversion from growth expectations when looking at stock prices alone. By using a broad cross-section of anomaly portfolios and a term-structure model, the authors attempt to map how the market's "fear" (risk premium) and "optimism" (growth expectations) shift in response to central bank signaling.
From a methodological standpoint, a peer reviewer would likely question the statistical insignificance of the risk premium shifts. The authors acknowledge that the economic magnitude is small and the results are not statistically significant, yet they still draw a conclusion about a "parallel upward shift." This is a common tension in financial research where economic intuition is used to interpret noisy data. Furthermore, the reliance on high-frequency futures data to define "surprises" assumes that the futures market is an efficient proxy for aggregate expectations, a premise that is generally accepted but remains a potential point of failure.
The findings extend existing literature by suggesting that the "information channel" is asymmetric. While dovish shocks clearly signal growth pessimism, hawkish shocks are more ambiguous—they may signal inflation (bad) or economic strength (good), which explains the lack of a corresponding drop in growth expectations. For this to matter in the real world, investors would need to shift from viewing the Fed as a mere "cost of capital" provider to viewing it as a primary signal for macroeconomic health.
Bridge Questions: How would these results change if the model accounted for quantitative easing (balance sheet shocks) rather than just interest rate shocks? To what extent does the "stability" of the 3% growth estimate reflect a true economic constant versus a limitation of the model's fitting process?
Counterstrike Scan: A coordinated campaign would use these findings to argue that the Fed's actions are the primary driver of market volatility to justify increased central bank intervention. The actual content does not match this pattern; it emphasizes that the effects are small and often statistically insignificant.