Central bank communications and equity ETFs

Abstract

This article examines effects of monetary policy surprises on returns, volatilities, trading volumes, and bid-ask spread of two equity ETFs, the S&P 500 SPY fund and the S&P 400 MDY fund. The policy surprises are measured by both surprises in the federal funds rate target changes and surprises in the future direction of the Federal Reserve monetary policy. The results show that there is an overreaction of the SPY to the federal funds rate target surprise in the first 5 minutes' trading and that both the SPY and the MDY returns, volatilities, trading volumes, and bid-ask spread react more strongly to surprise cuts than to surprise increases in the federal funds rate target. Quantitatively, after 45 minutes, an unanticipatedThe authors thank Refet Gurkaynak for kindly providing some data used in this study, seminar participants at the 2005 FMA annual meetings and the Union College, and particularly an anonymous referee for many helpful comments. 25-basis-point cut in the federal funds rate target is associated with an increase of 1.2 and 1.6% in the SPY and the MDY, respectively, while an unanticipated 25-basis-point decline (or rise) in the four-quarter-ahead eurodollar futures rate is associated with an increase (or decrease) of 0.71 and 0.40% in the SPY and the MDY, respectively. Further evidence also suggests that the market reacts more strongly to surprises in the future direction of monetary policy during the monetary tightening period and that the impact of monetary policy surprises depends on their sizes.

U.S. Monetary Policy Surprises and International Securitized Real Estate Markets

“…The decomposition appears to work very well, and the correlation coefficient between the target factor and the surprises in the federal funds target rate is over 95%. The path factor is shown to have a significant effect on financial markets in several earlier studies (Hausman and Wongswan 2006;Wang et al 2006Wang et al , 2008Wongswan 2009). …”

“…The path factor is designed to represent the surprises in FOMC's possible future policy (and its interpretation of economic outlook) as reflected in the wording of the FOMC statements. Closely following Gurkaynak et al (2005) and several subsequent studies (Hausman and Wongswan 2006;Wang et al 2006and Wongswan 2009), we also use a two-factor empirical specification in this paper.…”

“…Second, this paper examines not only the impact of surprises in the federal funds target rate on securitized real estate markets as explored in previous literature (e.g., ), but also the impact of surprises in the fed's future monetary policy directions on the markets. This paper extends the recent central bank communication literature on other U.S. financial markets (Gurkaynak et al 2005;Hausman and Wongswan 2006;Wang et al 2006and Wongswan 2009) and uses two factors to better measure U.S. monetary policy surprises. To the best of our knowledge, this is the first paper to investigate the impacts of two factors (both the target and path factors) on real estate markets.…”

“…As a result, the potential impact of FOMC statements or the so-called central bank communication has captured a lot of attention recently. 1 Extending earlier studies focusing on the federal funds rate as the main indicator of U.S. monetary policy (e.g., Kuttner 2001 andKuttner 2005), several recent studies have documented significant effects of unanticipated monetary policy surprises implied in FOMC statements on different asset markets, such as the stock market, bond market, and foreign exchange markets (Gurkaynak et al 2005;Hausman and Wongswan 2006;Wang et al 2006and Wongswan 2009). Essentially, clear communication in the FOMC statements can help increase the near-term predictability of FOMC federal funds rate decisions, as documented in Bernanke et al (2004) and Pakko (2005).…”

Comparing U.S. and European market volatility responses to interest rate policy announcements

“…For instance, Bomfim (2003), Wang et al (2006), Basistha andKurov (2008), Chulia et al (2010), and Kurov (2010) find stock market return and volatility reactions to central bank communications. More related to our focus, recent literature has documented the relation between FOMC scheduled meetings and VIX changes.…”