The Impact Of Monetary Policy Surprises On Bond Markets (Research Proposal Sample)

THE IMPACT OF MONETARY POLICY SURPRISES ON BOND MARKETS. (GERMANY AND USA BOND MARKETS, 10 YEAR PERIOD)
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Contents TOC \o "1-3" \h \z \u List of Tables and Figures PAGEREF _Toc427944055 \h 3Abstract PAGEREF _Toc427944056 \h 4Introduction PAGEREF _Toc427944057 \h 5Monetary Policy Overview PAGEREF _Toc427944058 \h 6Identification and choice of Monetary policies PAGEREF _Toc427944059 \h 7Review of previous studies PAGEREF _Toc427944060 \h 91-day interest rates’ response to monetary policy PAGEREF _Toc427944061 \h 11Variance decomposition and monetary policy shocks PAGEREF _Toc427944062 \h 11Variance decomposition PAGEREF _Toc427944063 \h 11The Monetary policy of the US and the Local Currency sovereign yields. PAGEREF _Toc427944064 \h 14The other Advanced Foreign economies PAGEREF _Toc427944065 \h 14Response of Credit Costs to Monetary Surprise PAGEREF _Toc427944066 \h 17Focus on Germany PAGEREF _Toc427944067 \h 22Estimation of the baseline policy rule for the Fed PAGEREF _Toc427944068 \h 24Econometrics Framework PAGEREF _Toc427944069 \h 25Policy indicators and Instruments of choice PAGEREF _Toc427944070 \h 26Results of a Simple VAR PAGEREF _Toc427944071 \h 28Conclusion PAGEREF _Toc427944072 \h 29Analysis of Tables PAGEREF _Toc427944073 \h 30The additional Tests PAGEREF _Toc427944074 \h 55Number of lags=2 PAGEREF _Toc427944075 \h 60References PAGEREF _Toc427944076 \h 64
List of Tables and Figures
TOC \h \z \t "Quote" \c Table 1: Response of interest rates to the changes in Federal funds target PAGEREF _Toc427941871 \h 11
Table 2: Effect of the United States Monetary Policy on Shorter-term Foreign interest rates PAGEREF _Toc427941872 \h 15
Table 3: Effect of the United States Monetary Policy on Longer term foreign interest rates PAGEREF _Toc427941873 \h 15
Figure 1: One year rate shock with corporate and mortgage premia in the U.S. PAGEREF _Toc427941874 \h 19
Table 6: Descriptive statistics for monetary policy surprises in the United States. PAGEREF _Toc427941875 \h 21
Figure 3 GERMANY- LOG CPI PAGEREF _Toc427941876 \h 31
Figure 35: GERMANY- Residual-Actual-Fitted Graph PAGEREF _Toc427941877 \h 32
Figure 4: GERMANY- LOG GDP PAGEREF _Toc427941878 \h 33
Figure 5: GERMANY- LOG INTEREST_RATE PAGEREF _Toc427941879 \h 34
Figure 6: analysis of distribution data-Germany PAGEREF _Toc427941880 \h 35
Figure 7: Fig 11: Actual, fitted and Residual graph-Germany PAGEREF _Toc427941881 \h 35
Figure 8: cpi, gdp and Interest rates logs-Germany PAGEREF _Toc427941882 \h 36
Figure 9: Heteroskedasticity Test PAGEREF _Toc427941883 \h 37
Figure 10: Breusch-Godfrey Serial Correlation LM Test-Germany PAGEREF _Toc427941884 \h 38
Figure11: relationships between the CPI, GDP and the INTEREST RATES-US PAGEREF _Toc427941885 \h 39
Figure 12: USA- LOG CPI PAGEREF _Toc427941886 \h 39
Figure 13: Actual, fitted and Residual graph-USA PAGEREF _Toc427941887 \h 40
Figure 14:USA- LOG INTEREST_RATE PAGEREF _Toc427941888 \h 41
Figure 15: USA- LOG GDP PAGEREF _Toc427941889 \h 42
Figure 16: descriptive statistics values-USA PAGEREF _Toc427941890 \h 42
Figure 18: Breusch-Godfrey Serial Correlation LM Test-USA PAGEREF _Toc427941891 \h 44
Figure 19: USA- WALD TEST 1 PAGEREF _Toc427941892 \h 45
Figure 21: USA- WALD TEST 2 PAGEREF _Toc427941893 \h 46
Figure 21: USA- WALD TEST 3 PAGEREF _Toc427941894 \h 46
Figure 22: GERMANY- WALD TEST 1 PAGEREF _Toc427941895 \h 47
Figure 23: GERMANY- WALD TEST 2 PAGEREF _Toc427941896 \h 47
Figure 24: GERMANY- WALD TEST 3 PAGEREF _Toc427941897 \h 47
Figure 25: GERMANY- Chow test PAGEREF _Toc427941898 \h 48
Figure 26: USA- Chow test PAGEREF _Toc427941899 \h 48
Figure 27: USA-NORMALITY TEST PAGEREF _Toc427941900 \h 50
Figure 29: GERMANY- Breusch-Godfrey Serial Correlation LM Test PAGEREF _Toc427941901 \h 51
Figure 30: USA- Breusch-Godfrey Serial Correlation LM Test PAGEREF _Toc427941902 \h 51
Figure 31: USA- OLS TEST PAGEREF _Toc427941903 \h 51
Figure 32: USA- OLS TEST PAGEREF _Toc427941904 \h 52
Figure 33: GERMANY- Generalized Method of Moments PAGEREF _Toc427941905 \h 53
Figure 34: USA- Generalized Method of Moments PAGEREF _Toc427941906 \h 54
Abstract
This paper seeks to make an investigation on the impact of monetary policy surprises in the German and United States markets. This paper will show that the volatility of the stock returns is susceptible to the monetary policies in the United States. In the zones where Euro is the main currency, surprises in the monetary policy matter for the volatility of bond return. This paper finds results that are robust for the Euro zone stock markets, but not necessarily for other Euro zone bond markets. The research paper reveals that surprises in monetary policies have a great effect on the German stock return volatility in the bear phase of the market than the bull phase (Gagnon, Raskin, Remache and Sack, 2011). Additionally, the results of the research indicate a support of the claim that the stock return volatility is negatively correlated with the stock returns. This claim contradicts the predictions that are made by the many asset pricing models such as the CAPM and the ICAPM.
Introduction
This paper makes an examination of the effect of the monetary policy surprises, especially on the international bond returns, with particular focus on the Euro zone and the American markets. The paper also decomposes the international bond returns within the (Barakchian and Crowe, 2010). into news regarding the future returns, future inflation rate and the real interest rates. The manner in which interest rates respond to the Federal reserve actions has for long been a topic of huge discussions and has drawn interest from a large array of participants and policy makers. The natural concerns of the bondholders is the effect of the Fed reserve policy on the prices of bonds. More often than not, the first link of transmission of the Federal Reserve policy is from the Fed funds target to the various interest rates. This issue, the transmission, is often very vital in the assessment of the likely effectiveness of the monetary policies implemented by a government.
Monetary Policy Overview
In the contemporary world and Federal policy understanding, an increase in the target funds rate often leads to a corresponding increase in the market interest rates. This increase is often the result of changes in interest rates by the commercial banks. According to a research done by Eichengreen and Mody (2010), there is a very little or almost no effect of the Federal policies on the rates of interests. The study asserts that the relationship between the Federal policies and the long term interest rates are rather loose and more variable than being intact and fixed. The studies, however, did not make a distinction between the expected and unexpected actions and this failure purportedly led to the lack of close link between these two phenomena. This paper makes an effort to show that the response of the interest rates to the surprise nature of the Fed policy is stronger than the response to the change in the target itself. Amusingly, the rates’ response to the Fed policy changes remain uniform and minimal, supporting an argument that a short term structure contains little information about future changes of the short-term rates (Cochrane and Piazzesi, 2002).
In the United States, there has been a lot of research, particularly in macroeconomics that look at the effects of the unconventional monetary policy actions. These studies focus both on the impact on the monetary policy issues and the financial asset prices. The Federal Reserve unconventional monetary policy actions often have an impact on overseas markets. Though there is a relatively little evidence to relate the strength and the scope of this spillover to the effects on the different markets, there are indicators to show that these changes do have some effects. This paper systematically quantifies these differences in the transmission of the United States monetary policies to the international bond markets.
In the manner in which monetary policy is transmitted, often without surprises, considerations made are mainly in two forms that enable a motivation of a revisit to the classical topic involving monetary policies in various economies. Of these considerations, the first one takes a look at the contemporary conventional models of the transmission of monetary policy that treats the financial market with some ease. This conventional model however, faces a lot of criticism from economic analysts and is perceived as being in need of serious critical rethinking due to the recent economic crises. On a second view, the smooth frameworks have had a very sharp predictions that point towards how the credit costs should be changing, especially in response to the monetary policy occurrences. The effects of these changes are especially seen in the borrowing rates of commercial banks.
Identification and choice of Monetary policies
The choice of monetary policy in a given economic market revolves around major concerns of the central bank and (or) the concerned regulatory authorities that have the responsibility of determining and influencing the quantities and rates of growth of the money supply in the market. The Federal reserve of The United States has the roles of being in charge of the monetary policy and its implementation is done mainly by employing the operations and the actions that will have a short-term influence on the interest rates. The U.S monetary policy is always determined and controlled by Federal Reserve. The Federal Reserve is also responsible for the provision of the functions of banks. The Federal Reserve has the ability to manipulate the money supply in the market in three main ways. The first, being one of the most basic is buying and selling o...