Market volatility, monetary policy and the term premium
Market volatility, monetary policy and the term premium
In this article, we use time-varying VAR models to study the effects of option-implied measures of equity and bond market volatilities on the government bond term premium and key macroeconomic variables. We show that the high correlation between the two volatilities requires the shocks to these variables to be jointly identified. We find that a positive shock to the VIX reduces the term premium. We interpret this effect as the result of investors shifting their portfolios away from riskier assets. Also, a positive shock to the VIX has contractionary and disinflationary effects. By contrast, a positive shock to the Merrill Lynch Option Volatility Expectations (MOVE), which reflects heightened uncertainty about future changes in interest rates, raises the term premium. Similar to a VIX shock, an increase in bond market volatility also has a contractionary effect, although the negative effects on output and inflation are smaller. Both VIX and MOVE shocks resemble negative demand shocks, albeit of different intensity, to which the central bank responds by easing monetary policy. Depending on the type of volatility impacting the economy, a contraction in output can be associated either with a flattening or steepening of the yield curve.
208-237
Kumar, Abhishek
bf1591a0-5a8b-40ae-a3b3-6a4ef990564e
Mallick, Sushanta
24be23c0-3cb6-44b2-8255-f9204b17d06d
Mohanty, Madhusudan
f7043e05-34b8-48c2-96b5-45cf9d372c4b
Zampolli, Fabrizio
80a23dad-cc3a-4b5f-9804-215c858c48b2
Kumar, Abhishek
bf1591a0-5a8b-40ae-a3b3-6a4ef990564e
Mallick, Sushanta
24be23c0-3cb6-44b2-8255-f9204b17d06d
Mohanty, Madhusudan
f7043e05-34b8-48c2-96b5-45cf9d372c4b
Zampolli, Fabrizio
80a23dad-cc3a-4b5f-9804-215c858c48b2
Kumar, Abhishek, Mallick, Sushanta, Mohanty, Madhusudan and Zampolli, Fabrizio
(2022)
Market volatility, monetary policy and the term premium.
Oxford Bulletin of Economics and Statistics, 85 (1), .
(doi:10.1111/obes.12518).
Abstract
In this article, we use time-varying VAR models to study the effects of option-implied measures of equity and bond market volatilities on the government bond term premium and key macroeconomic variables. We show that the high correlation between the two volatilities requires the shocks to these variables to be jointly identified. We find that a positive shock to the VIX reduces the term premium. We interpret this effect as the result of investors shifting their portfolios away from riskier assets. Also, a positive shock to the VIX has contractionary and disinflationary effects. By contrast, a positive shock to the Merrill Lynch Option Volatility Expectations (MOVE), which reflects heightened uncertainty about future changes in interest rates, raises the term premium. Similar to a VIX shock, an increase in bond market volatility also has a contractionary effect, although the negative effects on output and inflation are smaller. Both VIX and MOVE shocks resemble negative demand shocks, albeit of different intensity, to which the central bank responds by easing monetary policy. Depending on the type of volatility impacting the economy, a contraction in output can be associated either with a flattening or steepening of the yield curve.
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e-pub ahead of print date: 22 August 2022
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Local EPrints ID: 475694
URI: http://eprints.soton.ac.uk/id/eprint/475694
ISSN: 0305-9049
PURE UUID: c816e8a2-9625-4464-bc43-9b5d4e516433
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Date deposited: 24 Mar 2023 17:59
Last modified: 17 Mar 2024 04:18
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Contributors
Author:
Abhishek Kumar
Author:
Sushanta Mallick
Author:
Madhusudan Mohanty
Author:
Fabrizio Zampolli
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