Market Volatility, Monetary Policy and the Term Premium

42 Pages Posted: 17 Jan 2017

See all articles by Sushanta Mallick

Sushanta Mallick

Queen Mary - University of London

Madhusudan S. Mohanty

Bank for International Settlements (BIS) - Monetary and Economic Department

Fabrizio Zampolli

Bank for International Settlements (BIS) - Monetary and Economic Department

Date Written: January 2017

Abstract

Based on empirical VAR models, we investigate the role of (option-implied) stock and bond market volatilities and monetary policy in the determination of the US 10-year term premium. Our preliminary findings are that an unexpected loosening of monetary policy - through a cut in the federal funds rate in the pre-crisis sample or an increase in bond purchases post-Lehman - typically leads to a decline in both expected stock and bond market volatilities and the term premium. However, while conventional monetary policy boosts economic activity in the precrisis period, bond purchases are found to have no statistically significant real effects postcrisis. Second, expected equity market volatility (VIX) is found to be more important than bond market volatility (MOVE). Pre-crisis, a shock to the VIX leads to a concomitant rise in the MOVE, a contraction of economic activity, a fall in broker-dealer leverage and a rise in the term premium, consistent with pro-cyclical swings in market liquidity. Post-crisis, an innovation to the VIX is instead associated with a drop in the term premium, suggesting the prevalence of flight to quality effects.

Keywords: bond market volatility, VIX, unconventional monetary policy, quantitative easing, long-term interest rate, term premia

JEL Classification: E43, E44, E52

Suggested Citation

Mallick, Sushanta K. and Mohanty, Madhusudan S. and Zampolli, Fabrizio, Market Volatility, Monetary Policy and the Term Premium (January 2017). BIS Working Paper No. 606. Available at SSRN: https://ssrn.com/abstract=2900861

Sushanta K. Mallick (Contact Author)

Queen Mary - University of London ( email )

School of Business and Management
Mile End Road
London, England E1 4NS
United Kingdom
+44 20 7822 7447 (Phone)

HOME PAGE: http://webspace.qmul.ac.uk/skmallick/

Madhusudan S. Mohanty

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Fabrizio Zampolli

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

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