Monetary Policy Shock and Financial Market Responses: An Empirical Study of Exchange Rate, Gold and International Equity Market

Abstract

The asset pricing behavior around Rate Decision of The Central Bank is both an important and interesting Economic phenomenon. Predicting the direction and level of asset prices are important activities in the real world practice for investors. In this paper, I applied the Linear, Non-linear and Time Series methods to estimate the short term price change of several financial markets after the rate decision of FOMC in U.S. Fed by examine the data from 1990 to 2013. Our finding is that part of the asset pricing behavior is predictable conditional on the information set of rate decision. The unexpected part of hiking and cutting of benchmark overnight interest rate have significant influence on some asset classes. In the linear estimation parts, I found that the 1 basis point unexpected cut of the Fed Fund rate by the Fed Reserve in U.S. will drive 11 ticks rise of gold prices with significant level of 0.01. In the non-linear estimation parts, if the Fed Reserve cut its interest rate unexpectedly by 125 basis points, the probability that the Japanese Yen rises will be about 0.91, gold price rises will be about 0.80, the HangSeng Index rises will be 1.00, and the TSE rises will be about 0.98. My results are consistent with the hypothesis of rational behavior of economic agents in financial market and the related theory such as UIP(Uncovered Interest Rate Parity), Gold price as a prediction of inflation and international transmission of monetary policy through equity market.