The Calming of Short-Term Market Fears and Its Long-Term Consequences: The Federal Reserve's Reaction to COVID-19

46 Pages Posted: 1 Feb 2021

See all articles by Mattia Bevilacqua

Mattia Bevilacqua

Systemic Risk Centre - London School of Economics

Lukas Brandl-Cheng

Systemic Risk Centre - London School of Economics

Jon Danielsson

London School of Economics - Systemic Risk Centre

Lerby Murat Ergun

Bank of Canada; London School of Economics & Political Science (LSE)

Andreas Uthemann

Bank of Canada; London School of Economics - Systemic Risk Centre

Jean-Pierre Zigrand

London School of Economics - Department of Finance, Systemic Risk Centre, and Financial Markets Group

Date Written: January 27, 2021

Abstract

We study the impact of five key Fed policy responses to the COVID-19 crisis on the stock market's fear of loss and fear of variability. Using a unique global dataset of option prices to construct the term structures of fear, up to ten years into the future, we find that FX swap lines have the most decisive impact on market fear, but only on the US and countries with access to the swaps. Liquidity support and macroprudential policies had a smaller but still significant impact, while policies aimed to support the wider economy did not affect fear. These results raise important questions on the trade-off between short-term market calming and long-term moral hazard, as well as the relative importance of central banks, and the importance of the Federal Reserve as a global liquidity provider.

Keywords: Fed, COVID-19, FX swap

JEL Classification: E00

Suggested Citation

Bevilacqua, Mattia and Brandl-Cheng, Lukas and Danielsson, Jon and Ergun, Lerby Murat and Uthemann, Andreas and Zigrand, Jean-Pierre, The Calming of Short-Term Market Fears and Its Long-Term Consequences: The Federal Reserve's Reaction to COVID-19 (January 27, 2021). Available at SSRN: https://ssrn.com/abstract=3774218 or http://dx.doi.org/10.2139/ssrn.3774218

Mattia Bevilacqua

Systemic Risk Centre - London School of Economics ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Lukas Brandl-Cheng

Systemic Risk Centre - London School of Economics ( email )

Houghton St, London WC2A 2AE, United Kingdom

Jon Danielsson (Contact Author)

London School of Economics - Systemic Risk Centre ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44.207.955.6056 (Phone)

HOME PAGE: http://www.riskreasearch.org

Lerby Murat Ergun

Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Andreas Uthemann

Bank of Canada ( email )

234 Wellington Street
Ottawa, Ontario K1A 0G9
Canada

London School of Economics - Systemic Risk Centre ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Jean-Pierre Zigrand

London School of Economics - Department of Finance, Systemic Risk Centre, and Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44 20 7955 6201 (Phone)
+44 20 7955 7420 (Fax)

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