Monetary policy uncertainty, investor sentiment, and US stock market performance: New evidence from nonlinear cointegration analysis

The purpose of this paper is to examine non‐linear and cointegrating relationships between monetary policy uncertainty, investor sentiment, and stock market for the US economy, via controlling for potential macroeconomic risk factors. We mainly utilize non‐linear autoregressive distributed lag (NARDL) approach and findings support an existing cointegration between the aforementioned variables. Our results also suggest that there is a bidirectional and negative relationship between US stock market performance and monetary policy uncertainty in the short‐run. Furthermore, the effect of monetary policy uncertainty on investor sentiment is significantly negative and not strongly asymmetric in the long‐run. On the other hand, in the short‐run, increasing investor sensitivity to macroeconomic shocks strongly increases monetary policy uncertainty, while reducing sensitivity does not have a significant impact on the monetary policy uncertainty. Finally, we find a positive and bi‐directional relationship between stock prices and investor sentiment both in the short‐ and long‐run. In the long‐run, decreasing investor sensitivity to macroeconomic fluctuations (becoming more optimistic) has a greater positive influence on stock prices than a negative influence on stock prices, since investors are becoming more pessimistic. Implications from our analysis are important to policy makers and investors for determining effective economic policy decisions and proper investment strategies.