Risk, asset pricing and monetary policy transmission in Europe: Evidence from a threshold-VAR approach

This paper investigates in how far monetary policy shocks impact European asset markets, conditional on different risk states. We distinguish between macroeconomic risk, economic-policy risk, and financial risk and separately extract three factors via principal component analysis from a set of candidate variables. These factors augment a threshold-vectorautoregressive model that contains assets and a short-rate. Impulse responses show that we indeed see state-dependency in the reaction of asset prices to monetary policy shocks. This indicates that asset markets distinguish between different types and states of risk. Investment-grade corporate bond yields show the most pronounced state-dependency if we distinguish between states of high and low economic-policy risk. Non-investment-grade corporate bond yields as well as equity of industrial firms face the strongest state-dependency for macroeconomic risk. Financial equity shows state-dependency for financial risk regimes. Further on, we illustrate that during periods of severe crisis, different risk regimes coincide. This impedes a clear delimitation among these three types of risk. As a consequence of our findings, monetary policy transmission via distinct asset prices highly depends on the degree of these different kinds of risk inherent in Europe.