In 2013 all ECB publications feature a motif taken from the €5 banknote.note: This Working Paper should not be reported as representing the views of the European Central Bank (ECB). The views expressed are those of the authors and do not necessarily reflect those of the ECB. ABSTRACTThe VIX, the stock market option-based implied volatility, strongly co-moves with measures of the monetary policy stance. When decomposing the VIX into two components, a proxy for risk aversion and expected stock market volatility ("uncertainty"), we find that a lax monetary policy decreases both risk aversion and uncertainty, with the former effect being stronger. The result holds in a structural vector autoregressive framework, controlling for business cycle movements and using a variety of identification schemes for the vector autoregression in general and monetary policy shocks in particular. The effect of monetary policy on risk aversion is also apparent in regressions using high frequency data. JEL Codes:E44, E52, G12, G20, E32 Keywords:Monetary policy, option implied volatility, risk aversion, uncertainty, business cycle 2 NON-TECHNICAL SUMMARYA popular indicator of risk aversion in financial markets, the VIX index, strongly co-moves with measures of the monetary policy stance in the United States. While the current VIX is positively associated with future (real) Fed funds rates, the relationship turns negative and significant after 13 months: high VIX readings are correlated with expansionary monetary policy in the mediumrun future (see Figure 1).The strong interaction between the VIX index, known as a "fear index" (Whaley (2000) (2005) ascribe the bulk of the effect to easier monetary policy lowering risk premiums, reflecting both a reduction in economic and financial volatility and an increase in the capacity of financial investors to bear risk. By using the VIX and its two components, we test the effect of monetary policy on stock market risk, but also provide more precise information on the exact channel.This article characterizes the dynamic links between risk aversion, uncertainty and monetary policy in a structural vector autoregressive (VAR) framework. Our VARs always include a business cycle indicator to control for business cycle movements. The main findings are as 3 follows. A lax monetary policy decreases risk aversion in the stock market after about nine months. This effect is persistent, lasting for more than two years. Moreover, monetary policy shocks account for a significant proportion of the variance of the risk aversion proxy. Monetary policy shocks have a significant impact on risk aversion also in regressions using high frequency data. The effects of monetary policy on uncertainty are similar but somewhat weaker.On the other hand, periods of both high uncertainty and high risk aversion are followed by a looser monetary policy stance but these results are less robust and weaker statistically. Finally, it is the uncertainty component of the VIX that has the statistically stronger effect on the business cyc...

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. The refereeing process of this paper has been coordinated by a team composed of Cornelia Holthausen, Kalin Nikolov and Bernd Schwaab (all ECB). Terms of use: Documents in EconStor mayThe paper is released in order to make the research of MaRs generally available, in preliminary form, to encourage comments and suggestions prior to final publication. The views expressed in the paper are the ones of the author(s) and do not necessarily reflect those of the ECB or of the ESCB. AcknowledgementsWe thank Philipp Hartmann for inspiring and supporting this project throughout all stages. Philipp also invented the indicator's name and its abbreviation CISS (pronounced like "kiss"). We thank Tommy Kostka for excellent research assistance and for several good ideas which helped improving the CISS. Very helpful comments from Geert Bekaert, Wolfgang Lemke, Simone Manganelli and an anonymous referee are gratefully acknowledged. We finally thank participants at the Euro Area Business Cycle Network conference "Econometric Modelling of Macro-Financial Linkages" in Florence and the 5th CSDA International Conference on Computational and Financial Econometrics in London for fruitful discussions and comments. However, the views expressed in this paper are those of the authors and do not necessarily reflect those of the European Central Bank, the Eurosystem or the Magyar Nemzeti Bank. CISS indicatorPlease find weekly updates of the CISS data here. cross-correlations between the subindices. As a result, the CISS puts relatively more weight on situations in which stress prevails in several market segments at the same time, capturing the idea that financial stress is more systemic and thus more dangerous for the economy as a whole if financial instability spreads more widely across the whole financial system. Applied to euro area data, we determine within a threshold VAR model a systemic crisis-level of the CISS at which financial stress tends to depress real economic activity. Dániel HollóKeywords: Financial system, Financial stability, Systemic risk, Financial stress index, Macro-financial linkages JEL Classifications: G01, G10, G20, E441 Non-technical SummaryThe recent financial and economic crisis revealed considerable gaps in the theoretical and empirical frameworks for analysing, monitoring and controlling systemic risk in the financial system. Academics and financial authorities all around the globe accordingly have been stepping up their efforts to improve the suit of tools...

In 2013 all ECB publications feature a motif taken from the €5 banknote.note: This Working Paper should not be reported as representing the views of the European Central Bank (ECB). The views expressed are those of the authors and do not necessarily reflect those of the ECB. ABSTRACTThe VIX, the stock market option-based implied volatility, strongly co-moves with measures of the monetary policy stance. When decomposing the VIX into two components, a proxy for risk aversion and expected stock market volatility ("uncertainty"), we find that a lax monetary policy decreases both risk aversion and uncertainty, with the former effect being stronger. The result holds in a structural vector autoregressive framework, controlling for business cycle movements and using a variety of identification schemes for the vector autoregression in general and monetary policy shocks in particular. The effect of monetary policy on risk aversion is also apparent in regressions using high frequency data. JEL Codes:E44, E52, G12, G20, E32 Keywords:Monetary policy, option implied volatility, risk aversion, uncertainty, business cycle 2 NON-TECHNICAL SUMMARYA popular indicator of risk aversion in financial markets, the VIX index, strongly co-moves with measures of the monetary policy stance in the United States. While the current VIX is positively associated with future (real) Fed funds rates, the relationship turns negative and significant after 13 months: high VIX readings are correlated with expansionary monetary policy in the mediumrun future (see Figure 1).The strong interaction between the VIX index, known as a "fear index" (Whaley (2000) (2005) ascribe the bulk of the effect to easier monetary policy lowering risk premiums, reflecting both a reduction in economic and financial volatility and an increase in the capacity of financial investors to bear risk. By using the VIX and its two components, we test the effect of monetary policy on stock market risk, but also provide more precise information on the exact channel.This article characterizes the dynamic links between risk aversion, uncertainty and monetary policy in a structural vector autoregressive (VAR) framework. Our VARs always include a business cycle indicator to control for business cycle movements. The main findings are as 3 follows. A lax monetary policy decreases risk aversion in the stock market after about nine months. This effect is persistent, lasting for more than two years. Moreover, monetary policy shocks account for a significant proportion of the variance of the risk aversion proxy. Monetary policy shocks have a significant impact on risk aversion also in regressions using high frequency data. The effects of monetary policy on uncertainty are similar but somewhat weaker.On the other hand, periods of both high uncertainty and high risk aversion are followed by a looser monetary policy stance but these results are less robust and weaker statistically. Finally, it is the uncertainty component of the VIX that has the statistically stronger effect on the business cyc...

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. While most of the debate has focused on the effects of QE on the US economy, foreign policy-makers -in particular in emerging markets-argued that QE policies have created excessive global liquidity and caused an acceleration of capital flows to EMEs. In turn, this capital flow surge is widely blamed for appreciation pressures on EME currencies and a build-up of financial imbalances in EMEs. Terms of use: Documents in EconStor mayTo shed some light on this issue, the paper analyses the effects of the Federal Reserve's unconventional policies on the US and on 65 foreign financial markets. Importantly, the paper extends the existing literature by investigating the effects on both global asset prices and capital flows. For this purpose, we use a relatively novel database of daily portfolio flows into bond and equity mutual funds, taking primarily a US investor perspective. In this way, we can track capital injections into funds (portfolio flows) across countries.We analyze different types of US unconventional monetary policy measures (liquidity operations, purchases of MBS and of US Treasuries) in order to understand whether and why QE1 and QE2 have exerted different effects on US and foreign markets. In contrast with most of the literature on US QE, which has focused narrowly on announcement effects, we make a distinction between announcements of Fed interventions and the actual market operations.The results in the paper illustrate how US monetary policy since 2007 has contributed to portfolio reallocation as well as a re-pricing of risk in global financial markets. First, we find that Fed measures in the early phase of the crisis (QE1) were highly effective in boosting bond and equity prices, especially in the US, and led to US dollar appreciation. Conversely, QE2 boosted equity prices worldwide and led to US dollar depreciation. Yet Fed policies functioned in a pro-cyclical manner for capital flows to EMEs and in a counter-cyclical way for the US. QE1 triggered a portfolio rebalancing across countries out of emerging markets (EMEs) into the US, while QE2 triggered rebalancing in the opposite direction. This finding may be interpreted as lending support to the concerns expressed by policymakers in EMEs. The results suggest that there are indeed global spillovers and externalities from monetary policy decisions in advanced economies. However, the paper is mute on whether such externalities are overall positive or negative for other economies. The potentially...

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. While most of the debate has focused on the effects of QE on the US economy, foreign policy-makers -in particular in emerging markets-argued that QE policies have created excessive global liquidity and caused an acceleration of capital flows to EMEs. In turn, this capital flow surge is widely blamed for appreciation pressures on EME currencies and a build-up of financial imbalances in EMEs. Terms of use: Documents in EconStor mayTo shed some light on this issue, the paper analyses the effects of the Federal Reserve's unconventional policies on the US and on 65 foreign financial markets. Importantly, the paper extends the existing literature by investigating the effects on both global asset prices and capital flows. For this purpose, we use a relatively novel database of daily portfolio flows into bond and equity mutual funds, taking primarily a US investor perspective. In this way, we can track capital injections into funds (portfolio flows) across countries.We analyze different types of US unconventional monetary policy measures (liquidity operations, purchases of MBS and of US Treasuries) in order to understand whether and why QE1 and QE2 have exerted different effects on US and foreign markets. In contrast with most of the literature on US QE, which has focused narrowly on announcement effects, we make a distinction between announcements of Fed interventions and the actual market operations.The results in the paper illustrate how US monetary policy since 2007 has contributed to portfolio reallocation as well as a re-pricing of risk in global financial markets. First, we find that Fed measures in the early phase of the crisis (QE1) were highly effective in boosting bond and equity prices, especially in the US, and led to US dollar appreciation. Conversely, QE2 boosted equity prices worldwide and led to US dollar depreciation. Yet Fed policies functioned in a pro-cyclical manner for capital flows to EMEs and in a counter-cyclical way for the US. QE1 triggered a portfolio rebalancing across countries out of emerging markets (EMEs) into the US, while QE2 triggered rebalancing in the opposite direction. This finding may be interpreted as lending support to the concerns expressed by policymakers in EMEs. The results suggest that there are indeed global spillovers and externalities from monetary policy decisions in advanced economies. However, the paper is mute on whether such externalities are overall positive or negative for other economies. The potentially...

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in Highlights• The financial and economic crisis has taught central banks a lesson. They were previously primarily concerned with maintaining price stability, but the crisis has produced evidence to show that monetary policy can contribute to the development (or the mitigation) of systemic risk in the financial sector. Monetary policy therefore needs to take financial stability implications into account, and the macroeconomic implications of bank supervision and regulation must also be considered.• It is therefore important to understand the linkages between financial risk, monetary policy and the business cycle. This paper considers the thinking to date on risk taking in monetary policy, presents comparative evidence for the euro area and the United States, and interprets the evidence using a macro dynamic stochastic general equilibrium model.• This approach produces three preliminary conclusions: central banks' monetary policy approaches affect, with time lags, the propensity of financial markets and banks to assume risk; it is possible to take account of these effects through macroeconomic models that embody optimising agents with limited information and include explicitly banking and financial sectors; and there is some indication that the modelling done in the paper can be used as the basis for predicting the relationship between monetary policy and the effect of risk on macroeconomic variables, though this area needs considerable further research. AbstractWe assess, through VAR evidence, the effects of monetary policy on banks' risk exposure and find the presence of a risk-taking channel. A model combining fragile banks prone to risk mis-incentives and credit constrained firms, whose collateral fluctuations generate a balance sheet channel, is used to rationalize the evidence. A monetary expansion increases bank leverage. With two consequences: on the one side this exacerbates risk exposure; on the other, the risk spiral depresses output, therefore dampening the conventional amplification effect of the financial accelerator.