The Response of Stock Market Volatility to Futures-Based Measures of Monetary Policy Shocks

Nikolay Gospodinov and Ibrahim Jamali
Working Paper 2014-14
August 2014

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In this paper, we investigate the dynamic response of stock market volatility to changes in monetary policy. Using a vector autoregressive model, our findings reveal a significant and asymmetric response of stock returns and volatility to monetary policy shocks. Although the increase in the volatility risk premium, futures-trading volume, and leverage appear to contribute to a short-term increase in volatility, the longer-term dynamics of volatility are dominated by monetary policy's effect on fundamentals. The estimation results from a bivariate VAR-GARCH model suggest that the Fed does not respond to the stock market at a high frequency, but they also suggest that market participants' uncertainty regarding the monetary stance affects stock market volatility.

JEL classification: C32, C58, E52, E58, G10, G12

Key words: stock market volatility, federal funds futures, monetary policy, variance risk premium, vector autoregression, bivariate GARCH, leverage effect, volatility feedback effect


The views expressed here are the authors' and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to Nikolay Gospodinov, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 30309-4470, nikolay.gospodinov@atl.frb.org; or Ibrahim Jamali, Department of Finance, Accounting and Managerial Economics, Olayan School of Business, American University of Beirut, Beirut 1107 2020, P.O. Box 11-0236, Riad El-Solh Street, Lebanon, ij08@aub.edu.lb.

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