A Tale of Four Tails: Inflation, the Policy Rate, Longer-Term Rates, and Stock Prices

42 Pages Posted: 3 Jan 2018

See all articles by Dominic Anene

Dominic Anene

Northwestern University

Stefania D'Amico

Federal Reserve Bank of Chicago

Date Written: 2017-12-19


We analyze empirical links between the perceived tail-risk of inflation, the policy rate, longer-term interest rates, and equity prices in the U.S. Their simultaneous changes enable us to distinguish between a systematic and "exogenous" response to monetary-policy news. And, those tail risks' co-movements are accounted for in quantifying the magnitude and persistence of their responses to key shocks. We find that: (i) in the medium-term, all four tail risks respond significantly and contemporaneously to domestic and foreign monetary-policy announcements, except for the equity tail risk to foreign policy; (ii) all four tail risks rarely change in response to other U.S. macroeconomic news; (iii) the directional pattern of their simultaneous reactions to policy announcements is often consistent with the systematic response to new information about the economic outlook rather than with the response to an exogenous shock; (iv) the few notable instances of the latter response are always in reaction to Fed announcements; and, (v) our impulse responses demonstrate that odds of extreme inflation outcomes and extreme policy-rate outcomes are tightly linked, and that both determine tail outcomes for longer-term interest rates but not for stock prices.

Keywords: Downside risk, derivatives, inflation, monetary policy

JEL Classification: C32, E52, E58, G12, G14

Suggested Citation

Anene, Dominic and D'Amico, Stefania, A Tale of Four Tails: Inflation, the Policy Rate, Longer-Term Rates, and Stock Prices (2017-12-19). FRB of Chicago Working Paper No. WP-2017-26. Available at SSRN: https://ssrn.com/abstract=3093860

Dominic Anene (Contact Author)

Northwestern University

2001 Sheridan Road
Evanston, IL 60208
United States

Stefania D'Amico

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

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