The Calming of Short-Term Market Fears and Its Long-Term Consequences: The Central Banks’ Dilemma

37 Pages Posted: 1 Feb 2021 Last revised: 22 Jan 2023

See all articles by Mattia Bevilacqua

Mattia Bevilacqua

Systemic Risk Centre - London School of Economics; University of Liverpool - Management School (ULMS)

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 20, 2023

Abstract

We study the short-term effects and long-term consequences of Fed crisis interventions on market fears --- the risk perception of large asset price drops. We extract daily fear term structures from option markets covering event horizons from two weeks up to 10 years ahead and use announcement surprises in a broad set of futures contracts and ETFs, covering equity, fixed income, and FX markets, to identify the unexpected component of Fed interventions. Focusing on the 2020 market turmoil, we find that the Fed impacts market fear via risk sentiment and information channels. The risk sentiment channel is the dominant channel for asset purchases and operates at the short to medium term. In contrast, the information channel strongly impacts long-term fears and is the dominant channel for interest rate policies.

Keywords: Fed, COVID-19, FX Swap

JEL Classification: E00

Suggested Citation

Bevilacqua, Mattia 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 Central Banks’ Dilemma (January 20, 2023). 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

University of Liverpool - Management School (ULMS) ( email )

Chatham St
Liverpool, L69 7ZH
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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