Impact of FOMC Cycle on Market Uncertainty: Evidence From Interest Rate Derivatives

40 Pages Posted: 15 Oct 2020

See all articles by Indradeap Chatterjee

Indradeap Chatterjee

affiliation not provided to SSRN

Marina Di Giacinto

University of Cassino

Claudio Tebaldi

Bocconi University - CAREFIN - Centre for Applied Research in Finance; Bocconi University - Department of Finance; Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research

Date Written: August 23, 2020

Abstract

This paper investigates how Federal Reserve (Fed) actions influence market uncertainty. We consider two kinds of Fed events: the day of the Federal Open Market Committee (FOMC) meeting -- which includes a policy statement, press conference and release of a Summary of Economic Projections -- and the day the minutes of the FOMC minutes are released -- which is typically set 3 weeks after the meeting. Unlike related papers focused on the issue, we measure market uncertainty by the implied volatility extracted from interest rate options, specifically swaptions. We use 1-month constant maturity volatility for swaptions over tenors ranging from one up to 30 years as they are reflective of how these volatilities are marked by dealers/market-makers and cover only one FOMC meeting/minutes release at a time. We use an event study approach along with extensive graphical analysis to evaluate the impact of Fed actions. The results show that 1-month constant maturity implied volatility increases marginally going into these events and falls much more significantly afterwards. Remarkably, the increase and reduction in uncertainty around a meeting is not reducing with increasing tenors, showing that the impact of information release has a similar impact over all horizons ranging from 1 to 30 years. If, on one side, this evidence witnesses the capacity of the central bank to control the long end of the curve, on the other it indicates the possibility that overreaction to news may generate the puzzling excess volatility which is observed in long term rates.

Keywords: FOMC cycle, monetary policy, swaption, implied volatility.

JEL Classification: E52, G12.

Suggested Citation

Chatterjee, Indradeap and Di Giacinto, Marina and Tebaldi, Claudio, Impact of FOMC Cycle on Market Uncertainty: Evidence From Interest Rate Derivatives (August 23, 2020). Available at SSRN: https://ssrn.com/abstract=3681535 or http://dx.doi.org/10.2139/ssrn.3681535

Indradeap Chatterjee

affiliation not provided to SSRN

Marina Di Giacinto (Contact Author)

University of Cassino ( email )

Via S. Angelo, Loc. Folcara
Cassino, Frosinone 03043
Italy

Claudio Tebaldi

Bocconi University - CAREFIN - Centre for Applied Research in Finance ( email )

Via Roentgen 1
Milan, 20136
Italy

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research ( email )

Via Roentgen 1
Milan, 20136
Italy

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