Bank Announcements Research Articles

Whatever it takes? Market maker of last resort and its fragility

We provide a theoretical framework to analyze the market maker of last resort (MMLR) role of central banks. Central bank announcement to purchase assets in case of distress promotes private agents’ willingness to make markets, which immediately restores liquidity decreasing the need for future intervention. That is, the central bank can reduce the usage of the facility ex post by announcing a large capacity ex ante. This comes with potential fragility due to the possibility of multiple equilibria. Central bank can eliminate the bad equilibrium by announcing a large enough facility. However, fragility resurfaces if market participants doubt central bank’s commitment. Furthermore, permanent access to MMLR may crowd out private liquidity making the intervention ineffective.

Inferring Dealer Networks in the Foreign Exchange Market Using Conditional Transfer Entropy: Analysis of a Central Bank Announcement.

The foreign exchange (FX) market has evolved into a complex system where locally generated information percolates through the dealer network via high-frequency interactions. Information related to major events, such as economic announcements, spreads rapidly through this network, potentially inducing volatility, liquidity disruptions, and contagion effects across financial markets. Yet, research on the mechanics of information flows in the FX market is limited. In this paper, we introduce a novel approach employing conditional transfer entropy to construct networks of information flows. Leveraging a unique, high-resolution dataset of bid and ask prices, we investigate the impact of an announcement by the European Central Bank on the information transfer within the market. During the announcement, we identify key dealers as information sources, conduits, and sinks, and, through comparison to a baseline, uncover shifts in the network topology.

Same actions, different effects: The conditionality of monetary policy instruments

This paper explores the signaling effect of central bank announcements clarifying the reaction function of policy interventions. We exploit the unique setting provided by ECB asset purchase programs. We find that the same action – purchases of identical assets – undertaken under different titles generates different responses. PSPP affects inflation swaps whereas PEPP impacts sovereign spreads, so that only the variables associated with the communicated rationale of each program react. We highlight the importance of clarifying the conditional path of policy instruments for the transmission of monetary policy. We also provide evidence of this signaling channel from other ECB and BoE announcements.

Monetary policy surprises on the banking sector: The role of the information and pure monetary shocks

This paper analyzes how monetary policy surprises in Chile affects the real and financial sector separating between a pure monetary policy shock and an information shock. Using inter-day movements of futures of interest rate in the banking system, we identify an information shock when labor data is released and a pure monetary policy shock when the central bank reveals their interest rate decision, and their effects are quantified through an external vector autoregression model. Our results suggest that a pure monetary policy shock produce an appreciation of nominal exchange rate, and contractionary effects on the economy. However, an information shock does not necessarily produce adverse effects. This paper contribute to the literature in two dimensions: studying the effect of the main driver behind the central bank announcements, and their transmission to the banking sector and consequently to the real and monetary sector.

Information effects of monetary policy

This study assesses two central bank announcements about monetary policy and the central bank’s assessment of the economic outlook. We examine whether these two components influence macroeconomic and financial variables under the effective lower bound (ELB) of short-term nominal interest rates in Japan. We identify two shocks: a surprise policy tightening that raises interest rates and reduces stock prices and the complementary positive central bank information shock that raises both. We find that the two shocks have different effects on the Japanese economy. In fact, a contractionary monetary policy shock decreases inflation rates, whereas a positive central bank information shock increases inflation rates. The evidence suggests that announcements conveying the central bank’s assessment of the economic outlook play a certain role in the transmission mechanism of monetary policy under the ELB. However, our study shows that the two series of shocks do not induce changes in output. This suggests that they have a limited impact on the economy.

Post-FOMC Drift

We study the patterns of stock returns around the Federal Reserve monetary policy announcements. Much of the existing literature interprets changes in short rates around the announcement windows as policy surprises. In contrast, we follow the “Fed information effect” literature, which posits that financial markets react to central bank announcements not just for unexpected changes in monetary policy stances (monetary policy news), but also for central bank’s assessment of economic conditions (non-monetary policy news). We identify the good/bad news using a combination of sign restrictions with high-frequency financial data. “Bad news” events are times when the market interpreted the Fed decisions/announcements as revealing negative Fed information about the economy, and vice versa for “good news” events. A novel finding is that following bad news events, we observe significantly positive stock returns in a 20-day period. This observation is largely consistent with a story of asymmetric effects of good and bad news on the level of uncertainty. Further analysis shows that the post-FOMC drift to economic news in Fed announcements is a market-wide phenomenon. A trading strategy that buys following “bad news” earns an excess return of 2.5% per year with a Sharpe ratio of 0.43.

Who pays the liquidity cost? Central bank announcements and adverse selection

AbstractThis study examines whether the composition of market participants contributes to shaping market liquidity around central bank announcements. By analyzing transaction‐level data from a stock index futures market, we find that the roles of foreign and domestic institutional investors in taking or providing liquidity, respectively, are switched following the news announcements. The participation of domestic (foreign) institutions is negatively (positively) associated with liquidity provision shortly after the announcements, whereas they provide (consume) liquidity in general. The change in domestic institutions' roles is attributed to their advantages in processing local news as it is pronounced when they actively participate. Domestic individuals remain largely noisy and unresponsive. Overall, the results support the existence of adverse selection costs in the order‐driven context and imply that institutional investors may trade with the wind when they have information superiority.

Central bank information effects and transatlantic spillovers

News about the economy contained in a central bank announcement can affect public expectations. This paper shows, using both event studies and vector autoregressions, that such central bank information effects are an important channel of the transatlantic spillover of monetary policy. They account for a part of the co-movement of German and US government bond yields around Fed policy announcements, and for most of this co-movement around ECB policy announcements. Consequently, ECB surprise interest rate hikes that spill over to US government bond yields reflect good news and are followed on average by easier, not tighter, US financial conditions and an economic expansion. In fact, they spill over similarly as positive European macroeconomic news surprises. By contrast, pure ECB “monetary policy shocks” do not spill over, in part because of the offsetting Fed policy stance.

Does the Russia-Ukraine war lead to currency asymmetries? A US dollar tale

We examine the impact of the Russia-Ukraine war on the value of global currencies against the US dollar (USD) using event study methodology and market model estimates. We show that the Russia-Ukraine conflict had a negative impact on the value of the global currencies; however, a region-by-region analysis shows that while European currencies (particularly the Russian rouble, Czech koruna, and Polish zloty) depreciated against the USD, Pacific currencies appreciated significantly, and the currencies of the Middle East and Africa (ME&A) are insignificant. We also show that due to the financial and economic sanctions imposed on Russia, as well as Poland and the Czech Republic's proximity to the war zone, their currencies have weakened significantly against the USD. Furthermore, the Russian Central Bank's announcement to peg the rouble with gold, has had a significant positive impact on the pan-American, European (particularly the Russian rouble and the Polish zloty), and ME&A currencies. The analysis reveals a group of currencies that are unaffected by exogenous shocks. Incorporating these stable currencies into a portfolio would reduce the risk of volatile currencies. Future research can help gain additional insights by combining them with other major currencies such as the Chinese yuan, Japanese yen, British pound, and euro.

Testing for UIP-Type Relationships: Nonlinearities, Monetary Announcements and Interest Rate Expectations

This paper tests for UIP-type relationships by estimating first a benchmark linear Cointegrated VAR including the nominal exchange rate and the interest rate differential as well as central bank announcements, and then a Smooth Transition Cointegrated VAR (STCVAR) model incorporating nonlinearities and also taking into account the role of interest rate expectations. The analysis is conducted for five inflation targeting countries (the UK, Canada, Australia, New Zealand and Sweden) and three non-targeters (the US, the Euro-Area and Switzerland) using daily data from January 2000 to December 2020. While we cannot confirm the validity of UIP in its strictest theoretical sense, we find evidence for the existence of an equilibrium relationship between the exchange rate and the interest rate differential. Specifically, the nonlinear framework appears to be more appropriate to capture the adjustment towards the long-run equilibrium, since the estimated speed of adjustment is substantially faster and the short-run dynamic linkages more significant. Further, interest rate expectations play an important role: a fast adjustment only occurs when the market expects the interest rate to increase in the near future, namely central banks are perceived as more credible when sticking to their goal of keeping inflation at a low and stable rate. Also, central bank announcements have a more sizeable short-run effect in the nonlinear model. Finally, the equilibrium relationship between the exchange rate and the interest rate differential holds better in inflation targeting countries, where monetary authorities appear to achieve a higher degree of credibility.

Dynamics of return and liquidity (co) jumps in emerging foreign exchange markets

We investigate the dynamics of return and liquidity (co) jumps for three of the most traded emerging market currencies vis-à-vis US dollar. Accordingly, an increase in the average bid-ask spread (realized volatility) significantly reduces the duration between consecutive return (liquidity) jumps, while liquidity and volatility only play a partial role on the duration between consecutive return-liquidity cojumps. There is also evidence of vicious return-liquidity spirals in views of the positive contemporaneous impact of liquidity jumps on volatility and return jumps on the bid-ask spread. Finally, scheduled macroeconomic news and central bank announcements increase the likelihood of both return and liquidity (co) jumps.

How much do the central bank announcements matter on financial market? Application of the rule-based trading system approach

This paper proposes a rule-based trading system to investigate how much the central bank’s announcements matter on a financial market. We design a novel investment strategy and we simulate trades in order to quantify their profitability in the out–of–sample period using the data from a broad financial market in Poland spanning across 3 segments: stock market, foreign exchange market and bonds market. Our results show that the individual transactions delivered profits in 72.7% cases. The overall profitability across all events and all trading horizons was positive in as many as 63.6% cases. Although the financial market in Poland was only moderately sensitive to the NBP central bank’s communication, the identified types of the monetary policy announcements are economically significant and very useful for the investors, who can trade based on them and exploit them directly in the design of the rule-based trading strategies.

On classifying the effects of policy announcements on volatility

The financial turmoil surrounding the Great Recession called for unprecedented intervention by Central Banks: unconventional policies affected various areas in the economy, including stock market volatility. In order to evaluate such effects, by including Markov Switching dynamics within a recent Multiplicative Error Model, we propose a model–based classification of the dates of a Central Bank's announcements to distinguish the cases where the announcement implies an increase or a decrease in volatility, or no effect. In detail, we propose two smoothed probability–based classification methods, obtained as a by–product of the model estimation, which provide very similar results to those coming from a classical k–means clustering procedure. The application on four Eurozone market volatility series shows a successful classification of 144 European Central Bank announcements.

Central bank transparency and market reaction in Brazil, Chile, and Colombia

Central banks of Brazil, Chile, and Colombia in the late 1990s pledged transparency in their monetary policy decisions. Univariate tests show improvements in the forecasts of monetary policy actions in Brazil and Colombia but not in Chile. Multivariate tests examining the response of market interest rates to central bank announcements show transparency efforts lowered monetary policy news and macroeconomic news in Brazil and only partially in Chile and Colombia. Transparency efforts are effective when accuracy of forecasts improves and variability is reduced. Finally, both short- and long-term rates are shown to be impacted by monetary policy news and macroeconomic news.

Unconventional monetary policy announcements and information shocks in the U.S.

We study unconventional policy shocks and information shocks associated with central bank announcements in the U.S. While unconventional policy shocks capture the direct influence of announced monetary policy actions, information shocks are associated with central bank information conveyed with the announcement. To disentangle these two types of shocks, we impose sign restrictions on high frequency changes in interest rates and stock prices around announcements. We find that information shocks lead to persistent declines in the 10-year government bond yield, whereas the actual unconventional policy shock induces only small interest rate responses. We also find that expansionary output effects of unconventional monetary policy are to some extent counteracted by the information shock.

Testing for Uip: Nonlinearities, Monetary Announcements and Interest Rate Expectations

This paper re-examines the UIP relation by estimating first a benchmark linear Cointegrated VAR including the nominal exchange rate and the interest rate differential as well as central bank announcements, and then a Cointegrated Smooth Transition VAR (CVSTAR) model incorporating nonlinearities and also taking into account the role of interest rate expectations. The analysis is conducted for five inflation targeting countries (the UK, Canada, Australia, New Zealand and Sweden) and three non-targeters (the US, the Euro-Area and Switzerland) using daily data from January 2000 to December 2020. We find that the nonlinear framework is more appropriate to capture the adjustment towards the UIP equilibrium, since the estimated speed of adjustment is substantially faster and the short-run dynamic linkages are stronger. Further, interest rate expectations play an important role: a fast adjustment only occurs when the market expects the interest rate to increase in the near future, namely central banks are perceived as more credible when sticking to their goal of keeping inflation at a low and stable rate. Also, central bank announcements have a more sizeable short-run effect in the nonlinear model. Finally, UIP holds better in inflation targeting countries, where monetary authorities appear to achieve a higher degree of credibility.

The evolution of European economic institutions during the COVID-19 crisis.

This article argues that the incomplete economic and institutional integration of the euro area has exposed the monetary union to increasing economic divergence, which could be deepened by the COVID‐19 crisis. We discuss how monetary and fiscal measures implemented at the onset of the pandemic have contributed to mitigate the economic consequences of lockdowns, but provided limited insurance to narrow economic gaps across member countries. However, EU countries agreed on July 21, 2020 to develop, for the first time, countercyclical fiscal transfers financed by common debt issuance. We discuss the potential of this instrument to contribute to improve the resilience of the eurozone.

The conditional stock market response to banks’ distressed asset sales on CDS availability

ABSTRACT This paper analyzes the stock market feedback on bank announcements of non-performing loan (NPL) sales, conditional on whether credit default swaps (CDS) are traded on the vendor bank’s debt or not. Using a sample of 259 NPL sale announcements from 2012–2018, we find that NPL sales are related to positive abnormal stock returns if there is no CDS trading on the vendor bank’s debt. In contrast, if a CDS on the bank’s debt is outstanding, we find a negative stock market reaction. Similarly, we provide evidence that the positive market reaction is muted for banks that are considered too-big-to-fail. While the regulator currently strengthens NPL sales, our results provide evidence that CDS trading reassigns banks’ risk exposure.

COVID-19: stock market reactions to the shock and the stimulus

ABSTRACT Using the WHO announcement on 11 March 2020 and the Federal Reserve Bank announcement on 9 April 2020 as two events that represent the shock and the stimulus, this study finds that COVID-19 caused a negative shock to the global stock markets, especially in emerging markets and for small firms. We find that the US stock market experienced positive abnormal returns from the Fed stimulus compared to other developed countries and emerging markets. We find that the positive abnormal returns from the stimulus were garnered by the US large firms instead of the small firms.

Optimal Monetary Policy when Information is Market-Generated

AbstractThe nature of the private sector’s information changes the optimal conduct of monetary policy. When firms observe their individual demand and use it as a signal of real shocks, the optimal policy consists in maximising the information content of that signal. When real shocks are deflationary (like labour supply shocks), the optimal policy is countercyclical and magnifies price movements, which contrasts with the exogenous information case, where optimal monetary policy is procyclical and stabilises prices. When the central bank communicates its information to the public, this policy is still optimal if firms pay limited attention to central bank announcements.