Fed VS S&P 500: Stock Market, (Household) Deposit Supply, and Bank Competition

Lun, 04/04/2022 - 13:00 / 14:00

403, Viale Romania

Speaker: Teng Huang , Luiss


We document that at the aggregate level, lagged S&P 500 Sharpe Ratio is as strong as change in the Fed Funds Rate, in explaining deposit growth. We argue that households use past performance of the stock market to make asset allocation decisions, so good stock market performance causes contractions in household deposit supply. We further argue that areas with more bank market power experience less deposit contractions when stock market causes contractions in deposit supply. The intuition is that market power makes bank deposit demand curve steeper, which attenuates the effects of contractions in the supply curve. Empirically, we find that 1 standard deviation increase in lagged Sharpe Ratio is associated with 1.28-1.79% contractions in deposit growth. However, using a more restrictive version of the identification strategy by Drechsler, Savov, and Schnabl (2017), we find that subsidiaries located in zip code areas with 1 standard deviation above the mean concentration level experience 0.38-0.45% less contractions in deposit growth, compared with subsidiaries of the same parent located in zip code areas with mean concentration level within the same city. Counties with more bank market power also experience less contractions in small business lending in response to high lagged Sharpe Ratio. Overall, our results suggest that bank market power plays important roles in insulating local deposit market from stock market fluctuations.