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Market volatility, monetary policy and the term premium

Author

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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:

    1. Morana, Claudio, 2017. "Macroeconomic and financial effects of oil price shocks: Evidence for the euro area," Economic Modelling, Elsevier, vol. 64(C), pages 82-96.
    2. repec:eee:ecmode:v:72:y:2018:i:c:p:391-409 is not listed on IDEAS
    3. repec:eee:ecmode:v:72:y:2018:i:c:p:140-150 is not listed on IDEAS
    4. repec:eee:ecmode:v:71:y:2018:i:c:p:234-246 is not listed on IDEAS

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    Keywords

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

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