The effect of monetary policy announcements on the debt and equity markets

We investigate the hypothesis that zero lower bound monetary policy has an effect on the correlations of financial assets. We evaluate the impact of the zero lower bound monetary policies of the Bank of Japan, the Bank of England, and the Federal Reserve on the bond and equity markets in Japan, the UK, the US, and the Eurozone.  We evaluate the bond markets using the Japanese 10-year Sovereign bond (JGB), UK 10-year bond (Gilt), US 10-year Treasury note (T-note), and German 10-year bond (Bund).  For the equity markets we use the Nikkei 225, FTSE 100, S&P 500, and Euro STOXX 600 as proxies for each regional market.  We also include gold and silver as control commodities.  Our analyses demonstrate significant changes not only in the evaluated assets’ correlations with each other, but also in their general behavior.  This has major implications for investment portfolio construction and provides useful insight for financial service regulators and the central banks themselves in monitoring the fragility and stability of the financial system.

The genesis of this paper comes from an investment portfolio manager at a major hedge fund in Connecticut, USA. This portfolio manager stated, “One more pragmatic thought might be to study the impact of zero-rate monetary policy on financial asset correlations; that’s an issue that keeps portfolio managers up at night.’’ 

As previously noted, we employ an event-study approach in an effort to contrast data behavior before- and during-ZLB implementation.  We construct a correlation matrix using all data over the entire time span of the data sets.  Next, we determine the ZLB implementation points and construct correlation matrices before and after these points.  Finally, we employ time-series analyses (TGARCH) to test the significance of changes in the volatility, before and during the ZLB implementation.  The changes in volatility suggest changes in the market activity associated with the financial assets being evaluated.