The information content of German discount rate changes

Abstract

Discount rate changes always receive considerable attention in financial markets. Two hypotheses compete to explain financial market reactions: the direct `borrowing cost effect' and the announcement effect. For the Bundesbank's discount rate changes after 1979 we find that market reactions cannot be attributed to a direct borrowing cost effect but exclusively to announcement effects. The empirical results indicate that interest rates react to changes in the discount rate to the extent that they are unanticipated. In contrast, the response to anticipated changes in the discount rate is small and insignificant. We proxy market anticipations by a multinomial logit-model combined with a dummy variable capturing non-quantifiable factors reported by the financial press. Moreover, we show that the response of interest rates declines along the term structure and with the switch to greater emphasis on repurchase operations in early 1985.