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The Liquidity Effect: Testing Identification Conditions Under Time-Varying Conditional Volatility

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Abstract

In the recent SVAR literature, the liquidity effect has been studied by imposing a variety of identifying restrictions required under the assumption that the SVAR fundamental disturbances are homoscedastic. Using typical SVAR processes, we first show that this assumption is not supported by the data and that the SVAR residuals are not characterized by common conditional scedastic structures. Under time-varying conditional volatility of residuals, we are then able to formally test typical sets of restrictions that have been imposed in previous studies. Our results indicate that to obtain a well characterized liquidity effect, one must measure monetary policy shocks as innovations in the Federal funds rate.

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Paper provided by CREFE, Université du Québec à Montréal in its series Cahiers de recherche CREFE / CREFE Working Papers with number 40.

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Length: 25 pages
Date of creation: May 1996
Date of revision:
Handle: RePEc:cre:crefwp:40

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Keywords: conditional heteroskedasticity; structural vector autoregressive process; recursive system; simultaneous system; short-run elasticities; dynamic responses;

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References

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  1. Ben S. Bernanke, 1990. "On the predictive power of interest rates and interest rate spreads," New England Economic Review, Federal Reserve Bank of Boston, issue Nov, pages 51-68.
  2. Christopher A. Sims, 1986. "Are forecasting models usable for policy analysis?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 2-16.
  3. Eric M. Leeper & David B. Gordon, 1991. "In search of the liquidity effect," International Finance Discussion Papers 403, Board of Governors of the Federal Reserve System (U.S.).
  4. Pagan, A.R. & Robertson, J.C., 1994. "Resolving the Liquidity Effect," Papers 277, Australian National University - Department of Economics.
  5. repec:fip:fedlpr:y:1995:i:may:p:33-54 is not listed on IDEAS
  6. Christopher A. Sims & Tao Zha, 1994. "Error Bands for Impulse Responses," Cowles Foundation Discussion Papers 1085, Cowles Foundation for Research in Economics, Yale University.
  7. Engle, Robert F & Susmel, Raul, 1993. "Common Volatility in International Equity Markets," Journal of Business & Economic Statistics, American Statistical Association, vol. 11(2), pages 167-76, April.
  8. Sims, Christopher A., 1992. "Interpreting the macroeconomic time series facts : The effects of monetary policy," European Economic Review, Elsevier, vol. 36(5), pages 975-1000, June.
  9. Gordon, David B & Leeper, Eric M, 1994. "The Dynamic Impacts of Monetary Policy: An Exercise in Tentative Identification," Journal of Political Economy, University of Chicago Press, vol. 102(6), pages 1228-47, December.
  10. Davidson, Russell & MacKinnon, James G., 1993. "Estimation and Inference in Econometrics," OUP Catalogue, Oxford University Press, number 9780195060119, September.
  11. Mervyn King & Enrique Sentana & Sushil Wadhwani, 1990. "Volatiltiy and Links Between National Stock Markets," NBER Working Papers 3357, National Bureau of Economic Research, Inc.
  12. James Dunn, 1973. "A note on a sufficiency condition for uniqueness of a restricted factor matrix," Psychometrika, Springer, vol. 38(1), pages 141-143, March.
  13. Bernanke, Ben S & Blinder, Alan S, 1992. "The Federal Funds Rate and the Channels of Monetary Transmission," American Economic Review, American Economic Association, vol. 82(4), pages 901-21, September.
  14. McCallum, Bennett T., 1983. "A reconsideration of Sims' evidence concerning monetarism," Economics Letters, Elsevier, vol. 13(2-3), pages 167-171.
  15. Eichenbaum, Martin, 1992. "'Interpreting the macroeconomic time series facts: The effects of monetary policy' : by Christopher Sims," European Economic Review, Elsevier, vol. 36(5), pages 1001-1011, June.
  16. Strongin, Steven, 1995. "The identification of monetary policy disturbances explaining the liquidity puzzle," Journal of Monetary Economics, Elsevier, vol. 35(3), pages 463-497, June.
  17. Lawrence J. Christiano & Martin Eichenbaum, 1991. "Identification and the Liquidity Effect of a Monetary Policy Shock," NBER Working Papers 3920, National Bureau of Economic Research, Inc.
  18. Adrian R. Pagan & John C. Robertson, 1995. "Resolving the liquidity effect," Review, Federal Reserve Bank of St. Louis, issue May, pages 33-54.
  19. Sims, Christopher A & Stock, James H & Watson, Mark W, 1990. "Inference in Linear Time Series Models with Some Unit Roots," Econometrica, Econometric Society, vol. 58(1), pages 113-44, January.
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Cited by:
  1. Guglielmo Maria Caporale & Andrea Cipollini & Panicos Demetriades, 2003. "Monetary Policy and the Exchange Rate During the Asian Crisis: Identification Through Heteroscedasticity," CEIS Research Paper 23, Tor Vergata University, CEIS.
  2. Mohamed Benbouziane & Abdelhak Benamar & Mustapha Djennas, 2010. "The Liquidity Effect In Algeria And Morocco: A Multivariate Threshold Autoregressive Investigation," Working Papers 525, Economic Research Forum, revised Jun 2010.

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