Market-Based Monetary Policy Uncertainty

52 Pages Posted: 30 Apr 2019 Last revised: 7 May 2020

See all articles by Michael Bauer

Michael Bauer

Universität Hamburg

Aeimit Lakdawala

Michigan State University - Department of Economics

Philippe Mueller

Warwick Business School Finance Group

Multiple version iconThere are 2 versions of this paper

Date Written: December 6, 2019

Abstract

An extensive literature studies the impact of monetary policy surprises---shifts in expected policy rates---on asset prices. This paper addresses the open question of how shifts in the uncertainty about future policy rates matter for the transmission of monetary policy to financial markets. To this end, we develop a novel measure of policy uncertainty based on derivative prices that can be used in event studies. We provide evidence for an FOMC uncertainty cycle, the systematic pattern of resolution of uncertainty on FOMC announcement days followed by a gradual ramp-up over the next two weeks. Furthermore, specific monetary policy actions have differential effects on uncertainty, with the most substantial shifts due to changes in the forward guidance provided by the FOMC. Changes in uncertainty have pronounced effects on asset prices, distinct from the effects of changes in expected policy rates. Moreover, the prevailing level of uncertainty determines the effectiveness of policy surprises: When uncertainty is low, monetary policy surprises have stronger effects on asset prices.

Keywords: Monetary Policy Uncertainty, Federal Reserve, Svent study, Monetary Transmission, Implied Volatility

JEL Classification: E43, E44, E47

Suggested Citation

Bauer, Michael and Lakdawala, Aeimit and Mueller, Philippe, Market-Based Monetary Policy Uncertainty (December 6, 2019). WBS Finance Group Research Paper, Available at SSRN: https://ssrn.com/abstract=3371160 or http://dx.doi.org/10.2139/ssrn.3371160

Michael Bauer (Contact Author)

Universität Hamburg ( email )

Von-Melle-Park 5
Hamburg, 20146
Germany

HOME PAGE: http://www.michaeldbauer.com

Aeimit Lakdawala

Michigan State University - Department of Economics ( email )

Agriculture Hall
East Lansing, MI 48824-1122
United States

HOME PAGE: http://aeimit.weebly.com

Philippe Mueller

Warwick Business School Finance Group ( email )

Gibbet Hill Rd
Coventry, CV4 7AL
Great Britain

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