The Effects of U.S. Monetary Policy Shocks on Portfolio Diversification

Abstract

We investigate the impact of changes in U.S. monetary policy on portfolio diversification. We build four different types of portfolios, including a U.S.-only, a stock-bond (60/40) portfolio, an international diversified stock portfolio, and an asset diversified portfolio. Our assets include the S&P 500 index, a developed market index (MSCI EAFE), an emerging market index (MSCI EM), gold, oil, and U.S. 10-year Treasury notes (10-year T-Note). We provide the following evidence. First, U.S. monetary policy is a risk factor in these global asset markets. Second, the results demonstrate that these markets, except for the 10-year Treasury notes, are unlikely to react to anticipated monetary policy changes. Third, we suggest that risk-averse investors can use U.S. 10-year Treasury notes and choose the stock-bond portfolio to hedge risks when monetary policy is volatile, as we find that all stock indexes, gold and oil respond more to U.S. monetary policy surprises than 10-year Treasury notes. Fourth, all portfolios are negatively related to the monetary policy surprise, and we contend that U.S. monetary policy may be a systemic risk that cannot be fully diversified.