The Impact of Unconventional Monetary Policies on European Financial Markets (T4)

The project aimed at estimating the impact of the different monetary economic tools on equity, sovereign, and corporate valuations in the EU. The idea behind the initial project was to apply the “identification through heteroskedasticity” method of Rigobon (2003) to understand the ultimate effect of monetary policy interventions on asset markets, with a particular focus on the US Federal Reserve (FED) and European Central Bank (ECB) recent quantitative easing programs. We thought this approach would have strong potentials to address this question based on the evidence in Rigobon and Sack (2004). The underlying assumption is that the heteroskedasticity induced by central banks interventions allows us to uncover its structural impact on financial markets overcoming issues of endogeneity.

However, as we explain further in the findings section, we discovered an overall lack of significance. We retained the original idea of tracing the effect of monetary policy shocks on international asset markets but opted for a more “reduced-form” methodology that takes both regimes (the different time periods) and changes in the variance-covariance structure (the announcement vs non-announcement days) into account. We do so by contrasting the correlation structure of market reactions between and within group of countries.

In the current manuscript, the choice of focusing on correlation-based measures is dictated by our empirical setup. To single out the effect of monetary policy announcements, our identification must rely on high-frequency (i.e., daily or weekly) information. To the best of our knowledge, data on capital flows or import/export are available only at low frequency (for most of the countries, annually). At this frequency, our analysis would be simply not feasible.

Despite this data limitation, we much share the view that it would be insightful to understand to what extent, if any, co-movements in asset prices reflect cross-sectional differences in the degree of openness. There, we relate a country’s loading on the first principal component – i.e., the extent to which that country responds to global shocks – to its degree of financial openness, trade openness, and their interaction. We carry this analysis at the annual frequency, for both ECB and FED announcements and for the equity and CDS markets.