The Federal Reserve’s balance sheet and overnight interest rates: Empirical modeling of exit strategies

This paper provides a comprehensive study of the interplay between the Federal Reserve’s balance sheet and overnight interest rates. We model both the supply of and the demand for excess reserves. Treating outright securities holdings of the Federal Reserve as a policy tool, we estimate the effects of unconventional monetary policy on overnight funding rates. Further, we offer the first empirical assessment of the FOMC’s principles of the exit strategy. Assuming a path for removing monetary policy accommodation that is consistent with the FOMC’s exit principles, we project that the federal funds rate increases to 70 basis points by 2016, settling in a corridor bracketed by the discount rate and the interest rate on excess reserves, as excess reserves of depository institutions decline to near zero.     

On real interest rate dynamics and regime switching

We find evidence of regime switching dynamics in the USA and the UK real interest rates over the period 1881–2003. For the UK, there is a regime in which the real interest rate displays a relatively stronger mean-reversion and a regime in which it displays a relatively weaker mean-reversion. The former regime is characterized by a relatively larger error in the estimation of the reversion parameter, and higher volatility. For the USA, the two regimes differ in volatility. The probability of transition from one regime to another is found to be significantly related to the inflation rate regime, and to the political regime. The results highlight the importance of regime switching in the dynamics of the real interest rate, as well as the role of inflation and political regimes in explaining this switching.     

Interest rate corridors and reserves

This paper evaluates reserves regimes versus interest rate corridors, which have become competing frameworks for monetary policy implementation. Rate corridors, relying on lending and deposit facilities to create ceilings and floors for overnight interest rates, evince mixed results on controlling volatility. Reserve requirements allow period-average smoothing of interest rates but, even if remunerated, are subject to reserve avoidance activities. A system of voluntary, period-average reserve commitments could offer equivalent rate-smoothing advantages. If central banks created symmetric opportunity costs of meeting or falling short of period-average reserve requirements (or commitments), they could achieve flat reserve demand on settlement day.     

操作目标利率的选择与传导 ——基于MLF利率与隔夜利率的实证检验

依据2014-2018年月度数据,运用VAR模型考量MLF利率与隔夜利率对贷款加权利率、商业银行行为以及金融市场利率与金融市场波动的影响.结果表明:MLF利率对贷款加权利率和商业银行行为的影响较大,隔夜利率对金融市场利率和金融市场波动的影响较大.鉴此,应利用MLF利率调节贷款加权利率与商业银行行为,利用隔夜利率调节金融市场利率与金融市场波动,当两种利率的调节效果收敛接近时,再最终确定唯一的操作目标利率.     

Implicit intraday interest rate in the UK unsecured overnight money market

This paper estimates the intraday value of money implicit in the UK unsecured overnight money market. Using transactions data on overnight loans advanced through the UK large value payments system CHAPS in 2003–2009, we find a positive and economically significant intraday interest rate. While the implicit intraday interest rate is quite small pre-crisis, it increases more than tenfold during the financial crisis of 2007–2009. The key interpretation is that an increase in implicit intraday interest rate reflects the increased opportunity cost of pledging collateral intraday and can be used as an indicator to gauge the stress of the payment system. We obtain qualitatively similar estimates of the intraday interest rate by using quoted intraday bid and offer rates and confirm that our results are not driven by the intraday variation in the bid-ask spread.     

Maintaining low inflation: Money, interest rates, and policy stance

This paper presents a systematic empirical relationship between money and subsequent prices and output, using US, euro area and Swiss data since the 1960-1970s. Monetary developments, unlike interest rate stance measures, are shown to provide qualitative and quantitative information on subsequent inflation. The usefulness of monetary analysis is contrasted to weaknesses in modeling monetary policy and inflation with respectively short-term interest rates and real activity measures. The analysis sheds light on the recent change in inflation volatility and persistence as well as on the Phillips curve flattening, and reveals drawbacks in pursuing a low inflation target without considering monetary aggregates.     

Intraday periodicity, calendar and announcement effects in Euro exchange rate volatility

This paper provides an analysis of intraday volatility using 5-min returns for Euro-Dollar, Euro-Sterling and Euro-Yen exchange rates, and therefore a new market setting. This includes a comparison of the performance of the Fourier flexible form (FFF) intraday volatility filter with an alternative cubic spline approach in the modelling of high frequency exchange rate volatility. Analysis of various potential calendar effects and seasonal chronological changes reveals that although such effects cause deviations from the average intraday volatility pattern, these intraday timing effects are in many cases only marginally statistically significant and are insignificant in economic terms. Results for the cubic spline approach imply that significant macroeconomic announcement effects are larger and far more quickly absorbed into exchange rates than is suggested by the FFF model, and underscores the advantage of the cubic spline in permitting the periodicity in intraday volatility to be more closely identified. Further analysis of macroeconomic announcement effects on volatility by country of origin (including the US, Eurozone, UK, Germany, France and Japan) reveals that the predominant reactions occur in response to US macroeconomic news, but that Eurozone, German and UK announcements also cause significant volatility reactions. Furthermore, Eurozone announcements are found to impact significantly upon volatility in the pre-announcement period.     

Macroeconomic announcements, volatility, and interrelationships: An examination of the UK interest rate and equity markets

This study investigates the intraday and daily pricing behavior of UK interest rate and equity index futures contracts. The paper initially examines the response of Short Sterling, Long Gilt, and FTSE100 to the release of scheduled macroeconomic announcements before employing dynamic time series techniques in order to reveal the nature of causal transmission patterns between these variables. In brief, short-term interest rates were found to be highly sensitive to indicators of prevailing economic conditions. However, the release of data important in the formation of inflationary expectations had a relatively subdued impact on long-term rates. Announcement effects appear somewhat ambiguous for the stock market. The analysis also reveals the bid-ask bounce and swift mean reversion in volatility to be important behavioral features of the return-generating process. Whilst the three variables appear to be bound by two cointegrating relationships, the tests for lead/lag relationships produce mixed results.     

Level-ARCH short rate models with regime switching: Bivariate modeling of US and European short rates

This paper introduces regime switching into level-ARCH models for the short rates of the US, the UK, and Germany. Once regime switching and level effects are included there are no gains from including ARCH effects. It is of secondary importance how the regime switching is specified. The estimated level parameters differ across countries. The corresponding new bivariate models show that the states of the US and UK short rate volatilities are not independent nor identical. There is Granger causality from the US to the UK short rate volatility state but not vice versa. There is no contagion between the US and UK volatility states. Equivalent results apply to the relation between the US and German volatility states.     

A jump-diffusion model for the euro overnight rate

In this work we introduce a jump-diffusion process for the euro overnight rate (the European over night index average) that is able to capture the main characteristics of this rate: (i) dynamics constrained to remain in the corridor of official rates fixed by the European Central Bank; (ii) mean reversion towards the official rate on main refinancing operations; and (iii) highly discontinuous pattern (with jumps), also without variations in the official rate. After calibrating the model parameters on historical data, we implement the model to price an overnight indexed swap. Finally, a comparison between our model and the most common short-term interest rate models is presented.     

"利率走廊"调控模式的机制与启示

在加拿大、新西兰和澳大利亚等国的货币政策实践中,"利率走廊"(Interest Rate Corridor)正逐渐取代公开市场操作的位置,从而在稳定货币市场利率中发挥重要作用.实践表明,利率走廊调控模式简单透明,有利于正确引导公众预期,并具有更好的调控效果.因此,我国也有必要考虑采用利率走廊调控模式以调控市场利率.     

Assessing the Time-Varying Interest Rate Sensitivity of Real Estate Securities

Abstract

This paper examines the sensitivity of real estate securities to changes in both market and central bank interest rates. It is commonly viewed that the traded real estate market is one of the industry sectors most susceptible to interest rate movements. This is due to traditional high levels of borrowing, the impact of rate changes on property yields and indirectly upon occupational demand and thus rental income. The results which are the first to examine the UK sector, highlight the impact of interest rates on UK property companies, in relation to both returns and volatility. The paper also illustrates that this sensitivity is not confined to periods of high and volatile interest rates as the sample period under examination is characterized by historically low and stable rates.     

The information content of Eonia swap rates before and during the financial crisis

Before August 2007, implied forward rates in the overnight interest swap rates closely reflected market expectations about the future path of the Eonia, and therefore, about the future course of the ECB’s monetary policy stance. Nevertheless, this link was weakened considerably during the most acute episode of the financial crisis. Using the expectations hypothesis of the term structure as a benchmark model for the determination of the overnight interest swap rates, we find that after May 2010 the monetary transmission mechanism was partially restored when the ECB implemented various ‘unconventional measures’ in response to the financial crisis. On the contrary, liquidity and credit risks are still present in unsecured deposit markets, distorting the pricing and transmission of the ECB monetary policy stance along the Euribor rates. These results should be of interest for regulators, financial institutions, and researchers in European money markets.     

Nominal Interest Rates and the News

This paper provides new estimates of the impact of monetary policy actions and macroeconomic news on the term structure of nominal interest rates. The key novelty is to parsimoniously capture the impact of news on all interest rates using a simple no‐arbitrage model. The different types of news are analyzed in a common framework by recognizing their heterogeneity, which allows for a systematic comparison of their effects. This approach leads to novel empirical findings. First, monetary policy causes a substantial amount of volatility in both short‐term and long‐term interest rates. Second, macroeconomic data surprises have small and mostly insignificant effects on the long end of the term structure. Third, the term‐structure response to macroeconomic news is consistent with considerable interest‐rate smoothing by the Federal Reserve. Fourth, monetary policy surprises are multidimensional while macroeconomic surprises are one‐dimensional.     

Regime switching in the relationship between equity returns and short-term interest rates in the UK

This paper examines the relationship between UK equity returns and short-term interest rates using a two regime Markov-Switching EGARCH model. The results suggest one high-return, low variance regime within which the conditional variance of equity returns responds persistently but symmetrically to equity return innovations. In the other, low-mean, high variance, regime equity volatility responds asymmetrically and without persistence to shocks to equity returns. There is evidence of a regime dependent relationship between shorter maturity interest rate differentials and equity return volatility. Furthermore, there is evidence that events in the money markets influence the probability of transition across regimes.     

The Federal Reserve's Tools for Policy Normalization in a Preferred Habitat Model of Financial Markets

We develop a model to analyze monetary policy implementation with multiple Federal Reserve liabilities and superabundant reserves. The analysis demonstrates the Federal Reserve's tools including interest on excess reserves (IOER), overnight reverse repurchase agreements (ON RRP), and term deposits should allow the Federal Reserve to raise the short‐term interest rates to any desired level. We find the contribution of each the increase in the IOER and ON RRP offering rates in firming money market rates suggested by the data during the December 2015 policy tightening event is remarkably similar to the effect of each tool implied by the calibrated model.     

Social media and price discovery: The case of cross-listed firms

In this article, we examine whether social media information affects the price-discovery process for cross-listed companies. Using over 29 million overnight tweets mentioning cross-listed companies, we examine the role of social media for a link between the last periods of trading in the US markets and the first periods in the UK market. Our estimates suggest that the size and content of information flows on social networks support the price-discovery process. The interactions between lagged US stock features and overnight tweets significantly affect stock returns and volatility of cross-listed stocks when the UK market opens. These effects weaken and disappear 1 to 3 hr after the opening of the UK market. We also develop a profitable trading strategy based on overnight social media, and the profits remain economically significant after considering transaction costs.     

Purdah—On the Rationale for Central Bank Silence around Policy Meetings

Many central banks share the practice of purdah , a guideline of abstaining from communication around policy meetings. Although seemingly contradicting the virtue of transparency by withholding information precisely when it is sought after intensely, it has been justified on grounds that such communication may create excessive market volatility. This paper assesses the purdah for the Federal Reserve and confirms that financial markets are substantially more sensitive to central bank communication around policy meetings. Short-term interest rates react three to four times more strongly in the purdah before Federal Open Market Committee meetings than otherwise, and volatility increases (compared to a reduction otherwise).     

Further analysis of the expectations hypothesis using very short-term rates

Longstaff [Longstaff, F., 2000. The term structure of very short-term rates: new evidence for the expectations hypothesis. Journal of Financial Economics 58, 397–415] finds support for the expectations hypothesis at the very short end of the repurchase agreement (repo) term structure while other studies find calendar-time-based regularities cause rejection of the expectations hypothesis. Using Longstaff’s methods on a sample of repo rates that pre-dates Longstaff’s sample, we reject the expectations hypothesis for every maturity. The pre-Longstaff-sample repo data comes from a time period where the behavior of short-term interest rates is similar to the long-run average behavior of short-term interest rates. Our results imply that expectations hold when rates are less volatile and/or that we may be entering a period of lower volatility.     

The term structure of real interest rates: theory and evidence from UK index-linked bonds

This paper studies the behavior of the default-risk-free real term structure and term premia in two general equilibrium endowment economies with complete markets but without money. In the first economy there are no frictions as in Lucas (Econometrica 46 (1978) 1429) and in the second risk-sharing is limited by the risk of default as in Alvarez and Jermann (Econometrica 68 (2000) 775; Rev. Financial Studies 14 (2001) 1117). Both models are solved numerically, calibrated to UK aggregate and household data, and the predictions are compared to data on real interest rates constructed from the UK index-linked data. While both models produce time-varying risk or term premia, only the model with limited risk-sharing can generate enough variation in the term premia to account for the rejections of expectations hypothesis.