The Response of Stock Market Volatility to Futures-Based Measures of Monetary Policy Shocks
33 Pages Posted: 4 Apr 2015
Date Written: August 1, 2014
In this paper, we investigate the dynamic response of stock market volatility to changes in monetary policy. Using a vector autoregressive model, our findings reveal a significant and asymmetric response of stock returns and volatility to monetary policy shocks. Although the increase in the volatility risk premium, futures-trading volume, and leverage appear to contribute to a short-term increase in volatility, the longer-term dynamics of volatility are dominated by monetary policy's effect on fundamentals. The estimation results from a bivariate VAR-GARCH model suggest that the Fed does not respond to the stock market at a high frequency, but they also suggest that market participants' uncertainty regarding the monetary stance affects stock market volatility.
Keywords: stock market volatility, federal funds futures, monetary policy, variance risk premium, vector autoregression, bivariate GARCH, leverage effect, volatility feedback effect
JEL Classification: C32, C58, E52, E58, G10, G12
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