Unanticipated Interest Rate Research Articles

Firms’ expectations and monetary policy shocks in the euro area

We investigate the impact of monetary policy shocks on firms’ selling price and production expectations utilizing a proxy structural vector autoregressive (SVAR) model for ten euro-area economies during the period from 1999:1 to 2018:6. To identify monetary policy shocks, we utilize instruments such as a narrative measure of monetary policy. Our estimated impulse responses indicate that firms initially revise their expectations in a manner consistent with imperfect information theoretical settings, e.g., increasing their production and selling price expectations after an unanticipated interest rate hike. Interestingly, we observe an overshooting pattern consistent with firms’ learning over time. Following the initial surprise that leads firms to raise their production and selling price expectations after an unanticipated interest rate hike, firms gradually come to expect contractionary monetary policy shocks to decrease economic activity, consistent with initially imperfectly informed firms revising their expectations in accordance with a learning process about the economy.

Interest Rate Sensitivity of Non-banking Financial Sector in India

Executive Summary Before financial liberalization, interest rates were administered and exhibited near-zero volatility. The easing of financial repression in the 1990s generated experiences with interest rate volatility in India. Administrative restrictions on interest rates in India have been steadily eased since 1993. This has led to increased interest rate risk for financial firms. Most research studies have almost exclusively focused on the developed countries especially the banking sector of the United States. The present study attempts to examine the interest rate risk of non-banking financial institutions in India by using the methodology of panel regression and generalized autoregressive conditional heteroscedasticity (GARCH) (1, 1) model for the period from 1 April 1996 to 30 August 2014. The sample used in the study consists of all non-banking financial companies (NBFCs) listed in the S&P CNX 500 index which has continuous availability of share prices over the study period. The study also examines the impact of unanticipated changes in interest rate on stock returns of NBFCs. The Box–Jenkins methodology is applied to calculate unanticipated changes in interest rate variable, autoregressive integrated moving average (ARIMA) (24, 1, 0) model. The time series used in the present study is found to be stationary at the first logarithmic difference. Stock returns exhibit significant exposure with both market returns and interest rate changes. The interest rate sensitivity of large, medium, and small financial institutions is also found to be different. Estimation results for the variance equation in GARCH (1, 1) model suggest that the volatility for individual firm stock returns is time-variant. The ARCH and GARCH coefficients are found to be significant, providing evidence against using traditional model (ordinary least square (OLS)) that assumes time-invariant volatility. This implies that the market has a memory longer than one period and volatility is more sensitive to its own lagged values than it is to new surprises in the market. This study also investigates the possible determinants that account for cross-sectional variation in the interest rate sensitivity of NBFCs. It is found that the size of the firm is the preferred determinant that accounts for cross-sectional variation in the interest rate sensitivity of finance companies. When unanticipated changes in interest rate are used in lieu of actual interest rate changes, not much difference is observed in the significance coefficients. The only significant difference observed is in the magnitude. The impact of actual interest rate changes is more than the impact of unanticipated interest rate changes in absolute terms. This difference in the magnitude of impact arises because actual data incorporate movement in both anticipated and unanticipated components of interest rate. Hence, NBFCs managers and regulators should adopt policies and strategies to avoid the transmission of interest rate risk in their stock returns.

Examining the Asymmetric Impact of Monetary Policy in India

Though an accumulating body of work has analysed monetary policy transmission in India, there are few studies examining the asymmetric aspect of the transmission. Against this backdrop, segregating the interest rate setting process captured by a Taylor rule type into unanticipated and anticipated components, this article analyses the asymmetric effects of monetary policy on aggregate demand and its components, and inflation in India using quarterly data from 1996–97Q1 to 2013–14Q3. It finds that unanticipated hikes and cuts in the policy rate have a symmetric impact on aggregate demand, but differentially impact the components. While the impacts on investment are negative and symmetric, they are asymmetric on private consumption, with only an unanticipated cut in policy rate having a significant negative impact. Government consumption is unaffected by monetary policy shocks. The impact of unanticipated interest rate changes on inflation is negative and symmetric. Anticipated policy rate changes also have a negative impact on aggregate demand and its components, except for government consumption, but between certain levels, such changes are ineffective, indicating a neutral impact. Anticipated policy rate changes have a negative impact on inflation at all levels. JEL Classification: C32, C51, E31, E52

Public Real Estate and the Term Structure of Interest Rates: A Cross-Country Study

Using a variation of the Nelson-Siegel term structure model we examine the sensitivity of real estate securities in six key global markets to unexpected changes in the level, slope and curvature of the yield curve. Our results confirm the time-sensitive nature of the exposure and sensitivity to interest rates and highlight the importance of considering the entire term structure of interest rates. One issue that is of particular of interest is that despite the 2007–09 financial crisis the importance of unanticipated interest rate risk weakens post 2003. Although we examine a range of markets the empirical analysis is unable to provide definitive evidence as to whether REIT and property-company markets display heightened or reduced exposure.

Interest rate sensitivity and stock returns

This paper investigates the sensitivity of interest rate to stock return of financial institutions traded at Karachi Stock Exchange. Two Index Model of Stone and Bernell(1974) have been used to test the proposition of the present study. Three different portfolios of financial institutions have been examined against sensitivity of actual and unanticipated interest rates. Repo rate/Policy rate instead of t-bill rate is used for the proxy of interest rate. The data is collected from twenty nine financial institutions covering the time period from 2004 to 2011. Unit root test, co integration and error correction mechanism have been checked before proceeding to Two Index Model. For unanticipated interest rate risk ARIMA is proposed using Box Jenkins methodology. The findings of present study shows that stock returns of financial institution demonstrates positive sensitivity to market index and are statistically significant. However, sensitivity to interest rate is negative and statistically insignificant.

The time-varying response of foreign stock markets to U.S. monetary policy surprises: Evidence from the Federal funds futures market

In this paper, we estimate the time-varying response of foreign stock markets to U.S. monetary policy shocks derived from the high-frequency Federal funds futures market. Our results show significant time-variation in the response of the global equity markets to U.S. monetary policy surprises, where an unanticipated interest rate cut leads to an increase in stock returns. Our findings suggest that the foreign stock markets respond more to U.S. monetary policy surprises during the crisis periods. We also find that the stock markets in Europe and the U.S. responded negatively to unanticipated interest rate cuts by the Fed during the recent financial crisis.

The Time-Varying Response of Foreign Stock Markets to U.S. Monetary Policy Surprises: Evidence from the Federal Funds Futures Market

In this paper, we estimate the time-varying response of foreign stock markets to U.S. monetary policy shocks derived from the high-frequency Federal funds futures market. Our results show significant time-variation in the response of the global equity markets to U.S. monetary policy surprises, where an unanticipated interest rate cut leads to an increase in stock returns. Our findings suggest that the foreign stock markets respond more to U.S. monetary policy surprises during the crisis periods. We also find that the stock markets in Europe and the U.S. responded negatively to unanticipated interest rate cuts by the Fed during the recent financial crisis.

Monetary policy shocks and stock returns: evidence from the British market

This paper examines the impact of anticipated and unanticipated interest rate changes on aggregate and sectoral stock returns in the United Kingdom. The monetary policy shock is generated from the change in the 3-month sterling LIBOR futures contract. Results from time-series and panel analysis indicate an important structural break in the relationship between stock returns and monetary policy shifts. Specifically, whereas before the credit crunch, the stock market response to both expected and unexpected interest rate changes is negative and significant; the relationship becomes positive during the credit crisis. The latter finding highlights the inability, so far, of monetary policymakers to reverse, via interest rate cuts, the negative trend observed in stock prices since the onset of the credit crisis.

Does single monetary policy have asymmetric real effects in EMU?

This article compares reactions of economies in Economic Monetary Union (EMU) to a single monetary policy. For that, we estimate a reaction function supposed to represent the behaviour of European Central Bank over the period 1980–1998. Then residuals are introduced into the production equation of each country. We break up monetary shocks in two axes: first, anticipated against unanticipated shocks and then positive against negative shocks. These distinctions permit a best evaluation of the degree of homogeneity of the effects of monetary policy. France, Germany, Spain and Austria seem more sensitive to unanticipated interest rates increases contrary to Belgium and Italy. These results illustrate all the problem of single monetary policy.

Computing sunspot equilibria in linear rational expectations models

We provide a computationally simple method of analyzing the effects of fundamental and sunspot shocks in linear rational expectations models when the equilibrium is indeterminate. Under indeterminacy sunspots can affect model dynamics through endogenous forecast errors. Moreover, the effect of fundamental shocks on forecast errors is not uniquely determined. The solution method is illustrated with a New Keynesian dynamic stochastic equilibrium model that can be solved analytically. Under a passive interest-rate rule, the response of inflation to an unanticipated interest rate cut is ambiguous: there are some equilibria in which inflation increases and others in which prices fall.

Interest rate changes and common stock returns of financial institutions: evidence from the UK

The objective of this paper is to examine the impact of interest rate changes on the common stock returns of portfolios of financial institutions in the UK. The five groups of financial institutions examined are banks, insurance companies, investment trusts, property investment companies and finance firms. In addition, a wide sample of nonfinancial firms is considered for comparison purposes. A two-index model is employed to test the effect of both current and unanticipated interest rate changes. An element of volatility in market yields is also introduced in a three-index model to measure the effect of variability in interest rates on the returns of these financial intermediaries. Two main implications emerge from the present paper for both financial and nonfinancial firms. First, a significant negative relationship seems to exist between the common stock returns and the changes in interest rates. Second, common stock returns and variability of interest rates are related with a significant positive coefficient.

INTEREST RATE CHANGES AND COMMON STOCK RETURNS OF FINANCIAL INSTITUTIONS: REVISITED

AbstractIn this paper the interest rate sensitivity of common stock returns of financial firms is re‐examined. Considered here are (1) current, anticipated, and unanticipated changes in interest rates; (2) depository and nondepository firms; and (3) three different‐maturity interest rate indices. Results lend strong support for a negative effect of both current and unanticipated interest rate changes. Although some exceptions are observed, stock returns of most subsectors of both financial and nonfinancial firms are not sensitive to anticipated interest rate changes. The findings of this study are robust to the choice of a particular model of interest rate expectations.

Interest Rate Policy with Expectations of Devaluation

The problem of recurrent devaluations in the Nordic countries is dealt with using a simple rational expec tations model. Given imperfect international asset substitutability a nd sufficient foreign exchange reserves, a small open economy can use interest rate policies geared to competitiveness to put an end to re current devaluations. If this policy is known and credible, no intere st rate adjustments are called for, except shortly before and during the expected devaluation phase. In contrast, a completely unanticipat ed interest rate policy requires that the rate of interest be raised continuously as the expected devaluation date is approached. Copyright 1988 by The editors of the Scandinavian Journal of Economics.

Unanticipated interest rates, bank stock returns and the nominal contracting hypothesis

The relationship between unexpected interest rate movements and bank stock returns is analyzed in the context of the nominal contracting hypothesis. Unanticipated changes in interest rates should influence individual bank profits and stock returns depending on the maturity characteristics of their assets relative to their liabilities. This hypothesis is investigated by constructing portfolios on the basis of the nominal contracting positions of banks. The main conclusion of this paper is that the wealth redistribution implications of the nominal contracting hypothesis is found to be unimportant in the determination of bank stock returns.

Interest Rate Variability and Economic Performance: Further Evidence

Evans (1984) argues that a policy-induced rise in unanticipated interest rate volatility in 1980-82 substantially and significantly reduced output in the U.S. economy. He concludes that stabilizing interest rates is probably sensible monetary policy (p. 204). A second hypothesis, that increased volatility of money growth has contributed to stagnation, is rejected by Evans.' This comment raises some questions about the strength of Evans's conclusions and about the implicit channels of influence for his results. Evans's conclusion that only past unanticipated volatility affects output is theoretically and empirically weak. Anticipated changes in volatility are shown to have similar effects on output. Second, Evans implies that in Barro's (1981) output model the channel of the interest rate volatility effect on the economy is through an unanticipated decline in aggregate demand. The price level effect of such an unanticipated reduction in aggregate demand is tested in Barro's price equation. In examining these issues, an alternative measure of money

Interest Rate Variability and Output: Further Evidence

This paper provides a critique on “The Effects on Output of Money Growth and Interest Rate Volatility in the United States” by Paul Evans and offers alternative measures of interest rate variability as well as for money growth variability. These alternative measures were then used to conduct some of the tests reported by Evans. The results indicate that (1) it is not possible using Evan’s model to disentangle whether only unanticipated interest rate variability matters, (2) Evans’ results are sensitive to the measure of variability chosen, (3) one cannot reject the hypothesis that interest rate volatility did reduce output sharply and substantially between 1980-82 but interest rate volatility, in turn, rose because of an increase in the volatility of money growth and (4) in the model chosen by Evans to examine interest rate volatility effects, risk changes have dominant aggregate supply effects.

THE EXPECTED HOLDING PERIOD RETURN, THE TERM STRUCTURE OF INTEREST RATES AND INVESTMENT IN THE GOVERNMENT OF CANADA BOND MARKET*

THE OBJECTIVES of this thesis are threefold. First, an analysis of the Government of Canada bond market is undertaken with a view to ascertaining which of the extant theories of the term structure of interest rates is most representative of reality. Second, theoretically optimal investment strategies for investors constrained to this market are developed and third, what is theoretically optimal is compared with the portfolios which the Canadian chartered banks are actually holding. With respect to the first objective, the thesis is unique in a number of important respects. First, the unbiased expectations, liquidity preference and market segmentation theories of the term structure are restructured in terms of a holding period return concept in a more complete fashion than heretofore. Second, uncertainty, both in terms of a variance about an expectation and the more theoretically complete covariance with the market, is explicitly introduced into the analysis and the theories of the term structure, then viewed in the context of payments for risk undertaken. Third, investor horizons of 3 months through 5 years are employed in hopes of isolating certain market segments, and fourth, a procedure is developed for at least partially compensating for unanticipated interest rate movement, a problem which has given classical yield type term structure researchers a problem for some time. The analysis itself proceeds in the following fashion. Government of Canada bond data for the period January 1, 1949 through January 1, 1969 are utilized to generate expected holding period returns on instruments of maturity 3 months through 20 years in 3 month intervals for investor horizons of 3, 6, 12, 24 and 60 months, respectively. The results are then compared with the restructured models of the term structure and with various risk parameters. The conclusion is that there is strong evidence to support the existence of a multiple horizon market with a short horizon (3 months or shorter) and probably a series of longer horizons. The Canada market can not on the basis of this research be construed as segmented in the very rigid Culbertson sense, however, but rather should be viewed in the preferred habitat sense articulated by Modigliani and Sutch. The second objective is to develop an optimal portfolio strategy for a short horizon investor constrained to the government bond market, a market now construed as possessing multiple habitats only one of which is short. The third objective is to compare this strategy with that actually undertaken by the chartered banks, whom, it is argued, are the best institutional example of a short horizon investor. The optimal strategy is argued to be a well diversified portfolio of short bonds and, in comparing this with what the banks in aggregate actually held, a discrepancy is observed. The banks seem to be holding an excess of the longer instruments. A number of explanations for this are then advanced; in particular, a desire on the part of the government that the banks maintain the long end of the market, uncertainty with respect to bank holdings in the 3 to 5 year range and the bank's own view ofthemselves as superior interest rate forecasters.