Federal Reserve Bank of Chicago
Working Paper Series
A Tale of Four Tails: Inflation, the Policy Rate, Longer-Term Rates, and Stock Prices
We analyze empirical links between the perceived tail-risk of inflation, the policy rate, longer-term interest rates, and equity prices in the U.S. Their simultaneous changes enable us to distinguish between a systematic and "exogenous" response to monetary-policy news. And, those tail risks' co-movements are accounted for in quantifying the magnitude and persistence of their responses to key shocks. We find that: (i) in the medium-term, all four tail risks respond significantly and contemporaneously to domestic and foreign monetary-policy announcements, except for the equity tail risk to foreign policy; (ii) all four tail risks rarely change in response to other U.S. macroeconomic news; (iii) the directional pattern of their simultaneous reactions to policy announcements is often consistent with the systematic response to new information about the economic outlook rather than with the response to an exogenous shock; (iv) the few notable instances of the latter response are always in reaction to Fed announcements; and, (v) our impulse responses demonstrate that odds of extreme inflation outcomes and extreme policy-rate outcomes are tightly linked, and that both determine tail outcomes for longer-term interest rates but not for stock prices.
Cite this item
Dominic Anene & Stefania D'Amico, A Tale of Four Tails: Inflation, the Policy Rate, Longer-Term Rates, and Stock Prices, Federal Reserve Bank of Chicago, Working Paper Series WP-2017-26, 19 Dec 2017.
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
Keywords: Downside risk; derivatives; inflation; monetary policy
This item with handle RePEc:fip:fedhwp:wp-2017-26
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