The impact of the federal funds rate on an investor’s return

Abstract

The study aims to analyze stock price movements of the world’s widely used index S&P 500 and the rapid growing economy index of Dubai Financial Market (DFM). While UAE adopts a similar monetary policy to the US due to the pegging of the two countries’ currencies, UAE’s GDP and financial markets have been witnessing more robust performance since the financial crisis, raising the issue as to whether following monetary policy actions set by the Federal Reserve Bank is beneficial to the UAE financial markets. The paper investigates the effect of changes in Federal Funds Rate (FFR) on the domestic U.S. market returns studied through S&P 500 and the international UAE DFM market returns observed through DFM index. The models under analysis not only look at the effect of changes in the FFR on market indices’ returns, but also whether U.S. monetary policy reversals have a stronger effect than other changes, by imposing a dummy variable adjustment to the model. As part of robustness testing, further analysis is carried out by defragmenting the data into the pre and post financial crisis of 2008.  Findings suggest that the DFM index is highly sensitive to the change in FFR compared to S&P 500 index. Compared to the pre financial crisis, both the S&P500 Index and DFM Index are significantly affected by positive changes in the FFR.  Positive changes in the FFR tend to affect the DFM returns more negatively than S&P500 Returns, suggesting any future positive change in FFR would affect the financial markets negatively, by pulling prices down globally.