Working Paper

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


Abstract: 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.

Keywords: stock market volatility; federal funds futures; monetary policy; variance risk premium; vector autoregression; bivariate GARCH; leverage effect; volatility feedback effect;

JEL Classification: C32; C58; E52; E58; G10; G12;

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Bibliographic Information

Provider: Federal Reserve Bank of Atlanta

Part of Series: FRB Atlanta Working Paper

Publication Date: 2014-08-01

Number: 2014-14