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Can federal reserve policy deviation explain response patterns of financial markets over time?

  • WANG, Kent

    ()

    (The Wangyanan Institute for Studies in Economics, Xiamen University, China)

  • WANG, Shin-Huei

    ()

    (Université catholique de Louvain, CORE, Belgium)

  • PAN, Zheyao

    ()

    (The Wangyanan Institute for Studies in Economics, Xiamen University, China)

Yes. By using real-time structure break monitoring techniques we find evidence against monotonic response pattern, specifically three response structures of US stock market to the federal monetary policy actions based on a sample from 1989-2010. We re-estimate the market response in each of the three structures and find results stronger than previously documented especially in 2001-2008. We propose a “FedGap” variable which measures the deviation of Fed policy from the “Taylor Rule” in explanation and find it to be significant with economic meaning. We conclude that market responses proportionally to the size of the FedGap and it thus serves as a new “macro-state” factor which can explain the dynamic response patterns of financial markets. We also examine the issue from the bond market, and find similar results.

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Paper provided by Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) in its series CORE Discussion Papers with number 2013029.

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Date of creation: 04 Jul 2013
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Handle: RePEc:cor:louvco:2013029
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  1. repec:cup:cbooks:9780521715348 is not listed on IDEAS
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  3. repec:cup:cbooks:9780521887427 is not listed on IDEAS
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