Portfolio Balance Effects Research Articles

Quantitative easing and correlation dynamics in the aftermath of the Great Recession: A dynamic conditional correlation with exogenous variables approach

AbstractIdentifying the effects of quantitative easing (QE) on asset return correlations is critical to assessing such policies’ impact across financial markets. In this paper, we use a dynamic conditional correlation model that allows us to measure the impact of unconventional monetary policy on time‐varying correlations. Our results suggest that QE significantly affected correlations between stocks and bonds after the Great Recession via short‐term portfolio balance effects. The findings are critical for policy‐makers and practitioners alike. Central banks should consider the impact of monetary policy on asset correlations in their cost–benefit analyses. Likewise, portfolio managers are encouraged to factor in the effects of monetary policy on correlations to optimize portfolios and reduce potential losses strategically.

Portfolio balance effect of the U.S. QE between commodities and financial assets in commodity-exporting countries

This study analyses the portfolio balance channel of the U.S. quantitative easing (QE) by assessing the dynamic spillover effect between commodities and financial assets in commodity-exporting countries during QE. This study integrates the generalized spillover index initially proposed by Diebold and Yilmaz (2012) for the fractional integration VAR model. Then, we estimate the multivariate framework of the Westerlund and Narayan (2015) (WN)-based predictive model to quantify the effect of the portfolio balance channel on the net pairwise spillover index from the U.S. to other countries. Our results show: first, for bond yields, that Asian and Pacific bond yields are impacted by both commodity price indices returns and the U.S. bond yields across the sample periods. However, mixed evidence is found for both Latin America and Others; second, for equity, dynamic net return spillovers contribute mixed evidence across regional groups during QE. The diverse results are partly explained by the average percentage of commodity exports to total exports of the country and the degree of close interrelationship between countries. Additionally, dynamic return spillover analyses show that most foreign exchange returns are negative net spillovers during QE, supporting the behavior of “commodity currencies.” Last, the WN-based predictability models show pronounced differences in predictability across the selected commodity-exporting countries.

Modelling the Impact of Crude Oil Prices and Stock Price Index on Indonesia’s Exchange Rates

Abstract This paper employs various GARCH-type models and the daily data from 3 July 2006 to 30 June 2021 to examine the effect of crude oil prices and stock price index on exchange rates for Indonesia, the largest oil producer in Southeast Asia. Since the share markets and oil prices are very volatile, testing the stability of the parameters or system is desirable. We achieve this by using the Nyblom’s fluctuations test and account for the structural break associated with the fluctuations. Findings reveal that lower oil price return leads the Indonesian currency per US dollar to depreciate. In addition, we find that stock return has negative and significant relation with exchange rates. This lends support to the portfolio balance effect in which a decrease in stock prices leads to a depreciation of Indonesian Rupiah against the US dollar. Evidence from EGARCH model shows that shocks to the volatility of exchange rate have a symmetrical effect. Our results suggest that as lower oil prices and stock prices contributes to depreciation of Indonesia rupiah against USD, an appropriate monetary policy may require adjustment of interest rates to resist the exchange rate fluctuations without being detrimental to the banking system.

The Impact of U.S. Quantitative Easing (QE) Announcements on Indian Government Bond Yields

This study investigates the impact of U.S. Quantitative Easing (QE) announcements on Indian Treasury yields. Two outstanding channels of spillover effects on bond yields documented in the existing literature are signalingchannel and portfolio balance channel. This study decomposes Indian Treasury yields into yield expectationsand risk premia to measure spillover effects of U.S. QE announcements. The impact on yield expectationmeasures signaling effect while the impact on risk premia measures portfolio balance effect. It is observed that FOMC announcements of Federal Reserve’s Quantitative Easing (QE) policy treated as shocks to Indian government bond yields. To investigate the announcement effects on Indian government Bond yields, event study methodology is used to capture the change in the bond yields, yield expectation and risk premia of Indian bond market around that time especially during the first round of Quantitative Easing (QE1) policy announcement periods in one-day and two-day window period. To support event study results regression analysis method is implemented and found robust evidence supporting larger signaling effect than the portfolio balance effect. At last, this study uses Dynamic Nelson-Siegel (DNS) yield curve model to compute the relationship between the U.S. and Indian Bond market. DNS model involves two-step estimation using VAR regression on Indian government bond yields with U.S. 10-year Treasury yield changes as an exogenous variable. The statistical result of DNS estimation shows that U.S. 10-year Treasury yield change affects the Indian long-term bond yield during the financial crisis period.

Housing, the Credit Market and Unconventional Monetary Policies: From the Sovereign Crisis to the Great Lockdown

This paper develops a two-country model of a monetary union to evaluate the interaction between housing and unconventional monetary policies. The model is calibrated for the Euro Area and assesses the ECB’s Asset Purchase Programmes (APP) from 2015 until the Pandemic Emergency Purchase Programme (PEPP) in 2020. The model incorporates heterogeneous households, portfolio balance effects, a credit market susceptible to default, and nominal and real rigidities. In this paper the 2020 lockdown is studied as a negative signal from macroeconomic fundamentals which causes labor to grind to a halt. The model features the housing accelerator and the post-crisis house price double-dip. The findings illustrate the way in which macro-housing channels lead to self-reinforcing loops, affecting the portfolio rebalancing channel as the main way for asset purchases to influence the economy. The results show that asset purchasing performs better during a crisis, particularly if it is conducted for an appropriate extent of time. The findings illustrate that the PEPP should be extended until the covid-19 crisis phase is over and that it alone is not sufficient to accelerate the recovery; more actions, namely targeted fiscal policy, are required. Finally, the APP, PEPP and lockdown are assessed through a welfare analysis.

International Spillovers of Large-Scale Asset Purchases

AbstractThis paper evaluates the international spillover effects of large-scale asset purchases (LSAPs) using an estimated two-country dynamic stochastic general-equilibrium model with nominal and real rigidities and portfolio balance effects. Portfolio balance effects arise from imperfect substitutability between short- and long-term bond portfolios in each country, as well as between domestic and foreign bonds within these portfolios. We show that LSAPs in the United States lower long-term yields and stimulate economic activity not only in the United States, but also in the rest of the world (ROW) economy. This occurs despite the currency appreciation in the ROW and the resulting deterioration in their trade balance. The key for this result is the decline in the ROW term premia through the portfolio balance channel, as the relative demand for ROW long-term bonds increases following an LSAP in the United States. Our model indicates that US asset purchases that generate the same output effect as US conventional monetary policy has larger international spillovers due to stronger portfolio balance effects. We also show that international openness in financial markets reduces the stimulatory effects of LSAPs in the originating country, while increasing their international spillover effects.

Euro Area Quantitative Easing in a Portfolio Balance Model with Heterogeneous Agents and Assets

We develop a portfolio balance model to study the effects of Quantitative Easing (QE) on international financial asset returns through the portfolio balance channel. Our two-country model features heterogeneity in assets and investor preferences. Both are crucial for a meaningful model-based impact assessment of QE. Preferences for asset maturity, asset class (bonds, equities and currencies) and whether an asset is issued at home or abroad influence the substitutability of assets, which drives the portfolio balance effect of central bank asset purchases. We calibrate the two countries in our model to the euro area and a representative sample of rest-of-the-world (ROW) countries in order to estimate the international impact of the ECB’s asset purchase program announced in January 2015. When simulating our model, we find that central bank asset purchases decrease both domestic and foreign yields. While the effects of QE on domestic yields and the exchange rate are rather modest and smaller than commonly assumed in the literature, domestic stock prices increase substantially.

Transmission of Quantitative Easing: The Role of Central Bank Reserves

This article presents empirical evidence of a reserve-induced transmission channel of quantitative easing to long-term interest rates. Reserve-induced effects are independent of the assets purchased and run through the impact of reserve expansions on bank balance sheets and the resulting bank portfolio rebalancing. For evidence, we analyse the reaction of Swiss long-term government bond yields to announcements by the Swiss National Bank to expand central bank reserves without acquiring any long-lived securities. The data suggest that declines in long-term yields following the announcements mainly reflected reduced term premiums, consistent with reserve-induced portfolio balance effects.

Portfolio Balance Approach to Exchange Rate Determination: Testing a Model by Applying Bilateral Data of Turkey and United States1

Turkish economy started to be liberated in the beginning of 1980’s and gradually to be a part of global economic and financial system. But as a result of economic articulation of Turkey to the global world, global economic and financial headwinds have affected trade and economy especially via exchange rates. Since Turkey is of ever-growing foreign trade volume with global economic world determination of fluctuations in exchange rates has increased in importance. Due to global integration of financial markets, inflow and outflow of foreign bonds could cause economic agents to change currency composition of foreign assets to reduce the risks arisen from exchange rates. This situation can negatively affect exchange rates by fluctuating them. Aim of this study is to empirically investigate the portfolio balance effect on exchange rates. In this context, different version of Cushman’s model (2007) using monthly bilateral data of Turkey and U.S. covering the period 2006-2016 will be employed and portfolio balance approach to the exchange rates determination will be tested by performing cointegration test allowing for multiple structural breaks.

Portfolio balance effects and the Federal Reserve’s large-scale asset purchases

PurposeWhereas much of previous literature focuses upon the impact on yields from the Federal Reserve’s large-scale asset purchases (LSAPs), the purpose of this paper is to study the changes to expected returns.Design/methodology/approachThis empirical investigation offers support for changes to risk premia coincident with LSAPs.FindingsFor both equity and bonds, the authors find evidence for supply/demand LSAPs effects; the equity effects are consistent with a substitution effect from bonds to equities, whereas the bond effects appear to be an anomaly.Originality/valueThe findings represent new insight for weighing the efficacy and identifying the scope of LSAPs.

Revisiting Quantile Granger Causality Between the Stock Price Indices and Exchange Rates for G7 Countries

The daily data of the stock price index and the foreign exchange rate in G7 were utilized for the period between January 4, 1999 and June 30 2015. From the empirical study of Granger causality test in quantiles, there are three main findings. Firstly, there is no long-run significant relationship between the stock price index and exchange rate in G7. Secondly, different types of short-run relationships exist between the two variables among G7 countries. In Canada, Italy, and U.S.A., the relationship is bidirectional, and the asymmetric effect is at different quantiles. In France and Japan, the relationship is unidirectional, from the stock price index to the exchange rate, and the relationship is at different quantiles for the two countries. In Germany and U.K., the relationship is unidirectional in the opposite direction and is also at different quantiles. Lastly, it shows that international trading effects at different quantiles exist in Canada (at high quantile), Italy (at median quantile), and U.K. (at low quantile). On the other hand, portfolio balance effects at different quantiles exist in Germany (at low and median quantiles) and U.S.A. (at high quantile). The study shows neither effect in France and Japan. The empirical findings in this paper have important implications for academicians, international institutional investors, and policy-makers on the G7 markets.

Revisiting Quantile Granger Causality Between the Stock Price Indices and Exchange Rates for G7 Countries

The daily data of the stock price index and the foreign exchange rate in G7 were utilized for the period between January 4, 1999 and June 30 2015. From the empirical study of Granger causality test in quantiles, there are three main findings. Firstly, there is no long-run significant relationship between the stock price index and exchange rate in G7. Secondly, different types of short-run relationships exist between the two variables among G7 countries. In Canada, Italy, and U.S.A., the relationship is bidirectional, and the asymmetric effect is at different quantiles. In France and Japan, the relationship is unidirectional, from the stock price index to the exchange rate, and the relationship is at different quantiles for the two countries. In Germany and U.K., the relationship is unidirectional in the opposite direction and is also at different quantiles. Lastly, it shows that international trading effects at different quantiles exist in Canada (at high quantile), Italy (at median quantile), and U.K. (at low quantile). On the other hand, portfolio balance effects at different quantiles exist in Germany (at low and median quantiles) and U.S.A. (at high quantile). The study shows neither effect in France and Japan. The empirical findings in this paper have important implications for academicians, international institutional investors, and policy-makers on the G7 markets.

The interest rate effects of government bond purchases away from the lower bound

I analyze the recent experience of unconventional monetary policy in Sweden to study the interest rate transmission mechanisms of government bond purchases when interest rates are away from the lower bound. Using dynamic term structure models and event study regressions I find that government bond purchases have important portfolio balance and signaling effects. The signaling channel operates mainly by lowering short-rate expectations in the intermediate segment of the yield curve, while the portfolio balance channel is effective in lowering longer maturity term premia. In addition, I find that target interest rate policy and government bond purchases operate in different segments of the yield curve. This suggests that a combination of the two policies can be used to lower interest rates across the whole maturity spectrum, making monetary policy more expansionary.

Stock Price Index and Exchange Rate Nexus in African Markets

ABSTRACTThis paper examines the relationship between stock price index and exchange rate in six African markets using monthly data for the period January 2007 to October 2015. A quantile regression approach is used. This methodology is shown to perform better than the ordinary least squares estimators, particularly when the conditional distribution is heterogeneous. Our empirical evidence reveals an interesting pattern in the association of these two financial markets in Africa, which shows that the negative relationship between stock and foreign exchange markets is more apparent when exchange rates are extremely low or high. The negative relationship between the two variables is in line with the portfolio balance effect.

Friedman, Monetarism and Quantitative Easing

This paper argues that the theoretical origin of Quantitative Easing (QE) programs, as a general concept, clearly links to Friedman’s (and monetarist) ideas, but that the specific implementation of QE operations to cope with the 2008 financial crisis does not comply with key principles developed by Friedman. Based on Friedman’s work during the sixties, I contend that his monetary framework links to QE through what he (and Anna Schwartz) called the “monetary” effects of monetary policy and not the portfolio balance effect highlighted by Nelson (2011) and Bernanke (2012). The combination of the “monetary” effects and the stabilizing role of monetary policy should produce QE programs with a path of the monetary base (central bank assets) and M2 that differs dramatically from what transpired under the 2008-2014 QE arrangements based on the portfolio balance effect.

Transmission of Quantitative Easing: The Role of Central Bank Reserves

We argue that the issuance of central bank reserves per se can matter for the effect of central bank large-scale asset purchases—commonly known as quantitative easing—on long-term interest rates. This effect is independent of the assets purchased, and runs through a reserve-induced portfolio balance channel. For evidence we analyze the reaction of Swiss long-term government bond yields to announcements by the Swiss National Bank to expand central bank reserves without acquiring any long-lived securities. We find that declines in long-term yields following the announcements mainly reflected reduced term premiums suggestive of reserve-induced portfolio balance effects.

Portfolio Balance Effects and the Equity Market

Many monetary studies on the portfolio balance effect omit its impact to equity returns. Motivated through a simple general equilibrium model, we study how changes in the bond supply affect the overall equity market. Our model predicts that exogenous increases (decreases) in the bond supply coincide with a lower (higher) equity price, all else equal. A historical investigation from 1952-2014 discovers asymmetric effects, both leading to higher equity prices. While the portfolio balance channel explains how unexpected downward shifts in the bond supply lead to higher equity prices, empirical evidence suggests unexpected upward shifts coincide with higher inflation.

Currency intervention and the global portfolio balance effect: Japanese lessons

This paper extends the analysis of Bernanke et al. (2004) to show that the official Japanese purchases of foreign exchange in 2003–04 seem to have lowered long-term interest rates not only in the United States, but in a wide range of countries, including Japan. It seems that this decline was triggered by the investment of the intervention proceeds in US bonds and that global portfolio rebalancing spread the resulting decline in US dollar yields to bond markets in other currencies, thus easing global monetary conditions. We also show that the global portfolio balance effect is detectable in the response of yields to large Japanese intervention in data before and after 2003/04, though the effect is weaker. While our findings contribute to a growing body of work that points to common responses across bond markets to official portfolio shifts in the form of large-scale bond purchases (“quantitative easing”), our analysis has the advantage of focusing on a pure portfolio shock.

The relationship between stock prices and exchange rates in Asian markets

Purpose – The purpose of this paper is to estimate the relationship between stock prices and exchange rates of eight Asian countries. The analysis is based on methodologies that possess the ability to provide a complete representation of data series from both time and frequency perspectives simultaneously. In addition, instead of limiting the analysis to focus on the conditional mean of the response variable y in the regression equation, the authors investigate the extremes of distribution to reveal a range of hidden relationships between these variables. Design/methodology/approach – Given the limitations of classical methodology of Pearson correlation and least-squares regression, this study estimates the relationship between stock prices and exchange rates through wavelet correlation and cross-correlation to serve as a protocol for different traders who view the market with different time resolutions. In addition, quantile regression technique robust to heteroscedasticity, skewness and leptokurtosis is used to understand the relationship between stock prices and a specified quantile of the exchange rates. Findings – In accordance with the portfolio balance effect, it is observed that stock prices and exchange rates are negatively correlated at all frequencies. In particular, the negative correlation grows with higher time scales (lower frequency intervals). The findings from quantile regression also suggest that the coefficients are more inclined to be negative when exchange rates are extremely high. Originality value – The paper contributes to the literature by focussing on the multi-scale relationship between stock prices and exchange rates. In addition, it also analyzes the relationship between stock prices and a specified quantile of the exchange rates.

Modeling Sterilized Interventions and Balance Sheet Effects of Monetary Policy in a New-Keynesian Framework

We study a wide range of hybrid inflation–targeting (IT) and managed exchange rate regimes, analyzing their implications for inflation, output and the exchange rate. To this end, we develop an open economy new–Keynesian model featuring sterilized interventions as an additional central bank instrument operating alongside the Taylor rule and affecting the economy through portfolio balance effects in the financial sector. We find that there can be advantages, from a welfare perspective, to combining IT with some degree of exchange rate management via FX interventions. Unlike “pure” IT or exchange rate management via interest rates, FX interventions can help insulate the economy against certain shocks, especially shocks to international financial conditions. However, managing the exchange rate through interventions may also hinder necessary exchange rate adjustments, e.g., in the presence of terms of trade shocks.