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Market volatility, monetary policy and the term premium

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  • Sushanta K Mallick
  • Madhusudan Mohanty
  • Fabrizio Zampolli

Abstract

Based on empirical VAR models, we investigate the role of (option-implied) stock and bond market volatilities and monetary policy in the determination of the US 10-year term premium. Our preliminary findings are that an unexpected loosening of monetary policy - through a cut in the federal funds rate in the pre-crisis sample or an increase in bond purchases post-Lehman - typically leads to a decline in both expected stock and bond market volatilities and the term premium. However, while conventional monetary policy boosts economic activity in the precrisis period, bond purchases are found to have no statistically significant real effects postcrisis. Second, expected equity market volatility (VIX) is found to be more important than bond market volatility (MOVE). Pre-crisis, a shock to the VIX leads to a concomitant rise in the MOVE, a contraction of economic activity, a fall in broker-dealer leverage and a rise in the term premium, consistent with pro-cyclical swings in market liquidity. Post-crisis, an innovation to the VIX is instead associated with a drop in the term premium, suggesting the prevalence of flight to quality effects.

Suggested Citation

  • Sushanta K Mallick & Madhusudan Mohanty & Fabrizio Zampolli, 2017. "Market volatility, monetary policy and the term premium," BIS Working Papers 606, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:606
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    Cited by:

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    2. Turdaliev, Nurlan & Zhang, Yahong, 2019. "Household debt, macroprudential rules, and monetary policy," Economic Modelling, Elsevier, vol. 77(C), pages 234-252.
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    4. Batabyal, Sourav & Islam, Faridul & Khaznaji, Maher, 2018. "On the sources of the Great Moderation: Role of monetary policy and intermediate inputs," Economic Modelling, Elsevier, vol. 74(C), pages 1-9.
    5. Ben-Haim, Yakov & Demertzis, Maria & Van den End, Jan Willem, 2018. "Evaluating monetary policy rules under fundamental uncertainty: An info-gap approach," Economic Modelling, Elsevier, vol. 73(C), pages 55-70.
    6. Rohit, Abhishek Kumar & Dash, Pradyumna, 2019. "Dynamics of monetary policy spillover: The role of exchange rate regimes," Economic Modelling, Elsevier, vol. 77(C), pages 276-288.
    7. Gregor, Jiří & Melecký, Martin, 2018. "The pass-through of monetary policy rate to lending rates: The role of macro-financial factors," Economic Modelling, Elsevier, vol. 73(C), pages 71-88.
    8. Bennouna, Hicham, 2019. "Interest rate pass-through in Morocco: Evidence from bank-level survey data," Economic Modelling, Elsevier, vol. 80(C), pages 142-157.
    9. Zhengyang Chen, 2019. "The Long-term Rate and Interest Rate Volatility in Monetary Policy Transmission," 2019 Papers pch1858, Job Market Papers.
    10. Mendicino, Caterina & Zhang, Yahong, 2018. "Risk shocks in a small open economy: Business cycle dynamics in Canada," Economic Modelling, Elsevier, vol. 72(C), pages 391-409.
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    13. Bluwstein, Kristina & Yung, Julieta, 2019. "Back to the real economy: the effects of risk perception shocks on the term premium and bank lending," Bank of England working papers 806, Bank of England.
    14. Cavallaro, Eleonora & Cutrini, Eleonora, 2019. "Distance and beyond: What drives financial flows to emerging economies?," Economic Modelling, Elsevier, vol. 81(C), pages 533-550.
    15. D'Avino, Carmela, 2018. "Quantitative easing, global banks and the international bank lending channel," Economic Modelling, Elsevier, vol. 71(C), pages 234-246.

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    Keywords

    bond market volatility; VIX; unconventional monetary policy; quantitative easing; long-term interest rate; term premia;

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