1. DISSERTATION SUBMITTED IN PART FULFILMENT OF THE REQUIREMENTS FOR THE
AWARD OF THE DEGREE OF MFIN IN INTERNATIONAL FINANCE 2014/2015
The Impact of
Quantitative
Easing
Announcements
in the U.S. on
Equity Prices
Policy-rate Guidance, Interest
Rates & Communication
Surprises
Martin Reilly
Supervisor: Dr Heather Tarbert
20/08/15
2. 2
Abstract
This paper researched the effect that central bank monetary policy announcements had on
asset prices in the United States. Specifically, the analysis involved one hundred equities
from the New York Stock Exchange and the Nasdaq, as well as the three major US indices-
the S&P 500, the Dow Jones Industrial Average, and the Nasdaq Composite. The research
focused on seven major announcements made by the Federal Reserve regarding the large-
scale-asset-purchases (LSAPs) programme known in finance as QE3- Quantitative Easing.
Two tests were carried out to measure the statistical significance of the returns on the
announcement days- Z and Chi-Squared. The surrounding literature on the topic identified
three main segments of monetary policy communication: policy-rate guidance, interest rate
effects, and LSAPs. The potential effect of each one is addressed in this paper, with the first
two as research questions and the latter as the two hypotheses. An understanding of the
influence that announcements of this nature-especially in the midst of a recession- is
difficult to assess, and a recent focus has been scantly covered in the literature. Therefore
the researcher explored the extant literature on this topic, so as to be able to gain a better
understanding of the considerable impact that monetary policy communication appears to
have on financial markets. In addition, by making the focus as specific as possible- on one
type of security- and very recent, a new angle of approach could be assessed, leading to a
significant contribution.
3. 3
Contents
I: Introduction………………………………………………………………………………….………………………………4
II: Literature Review………………………………….………………………………………………………………….…8
Efficient-Market Hypothesis……………………………………………….………………………………………….…8
RQ1- Policy-rate Guidance and Communication………………….………………………………….…………8
RQ2- Monetary Policy Decisions- Interest Rates……………………………………………..……………...11
Principal Hypothesis- LSAP/QE3 Announcements……………………………………………………….……13
III: Methodology.……………………………….…………………………………………………....…………………...17
IV: Results and Discussion………………….…………………………………………………….……………........20
Fed Hints at QE3- Positive Surprise Effect (H1)………………………………………….…………….….....20
Fed Hints at QE3 Tapering- Negative Surprise Effect (H2)……………………………………….....… .21
The Implementation of QE3 Tapering…………………………………………………………….……………. ..22
Completion of QE3 Programme- Interest Rate Effects…………………………………………………....23
QE3 Policy Announcements (H3)…………………………………………………………………………………. ..25
Tables of Results of Different Equities………………………………………………………………………....…26
Z-Test- 2-sided Significance Test……………………………………………………...…………………………….28
V: Conclusion………………………………………………………………………………………………….……………..31
Appendix………………………………………………………………………………………………….……………………34
Bibliography……………………………………………………………………………………………………….….…..…35
4. 4
Introduction
An extensive amount of literature on the impact of policy announcements made by the
Federal Reserve- the US central Bank- and specifically the Federal Open Market Committee
(FOMC) on financial markets provides substantial evidence that this is an important
phenomenon. Specifically, the announcement and resultant use of unconventional
monetary measures undertaken by the Federal Reserve since 2008- in an attempt to
stimulate the economy after the Global Financial Crisis (GFC) - has had a profound impact on
equity markets, causing them to reach all-time highs on several occasions since March 2013.
The mere announcement of monetary policy measures alone can have a significant impact
on financial markets as it may signal possible indications of the current state of the economy
and how the FOMC may respond to this in the future (Joyce et al. 2010), (Reilly, 2015). As a
result of the GFC, central banks around the globe sought to counter the damaging effects
that rippled through the economy- causing a widespread and deep recession. In the words
of the current Chairperson of the Federal Reserve, the role of the FOMC is to “guide the US
economy towards ‘maximum employment, stable prices, and moderate long-term interest
rates’" (Walker, 2015). In this light, the central premise of this study- which focuses on
central bank communication and specifically related to quantitative easing- helps to identify
how this role is closely monitored by market participants, as it can have a significant effect
on financial markets.
The researcher decided to undertake this analysis because the effect that monetary
stimulus has on asset prices appears to be an integral part of understanding how the
financial markets are comprised. This tests to what extent they are truly efficient and how
quickly new information is processed into stock prices. As a result of the GFC, investors lost
considerable faith and confidence in the financial system, and it highlighted the importance
of transparency from lawmakers and the Federal Reserve. Therefore, the importance of
announcements related to spurring economic growth- and policy measures to realise this-
has moved to the forefront of investors’ attention. The takeover of many prominent large
businesses was essential to restoring a sense of confidence in the system, which was
severely lacking due widespread belief that economic policy was weak prior to and
subsequent to the crisis (Kates, 2011).
The policy of large-scale-asset-purchases (LSAPs), commonly referred to as quantitative
easing (QE) is a measure of unconventional monetary policy that is used when conventional
monetary policy fails to reduce long-term and short-term interest rates. It is designed to
encourage banks to lend when they may be hesitant to do so due to capital shortages
(Cassidy, 2009). Conventional policy becomes ineffective in encouraging spending- due to
the fact that they cannot go much below zero- as currency can be held by individuals rather
than being kept in banks (Fawley & Neely, 2013:51). The theoretical basis of QE is that a
5. 5
central bank creates money (digitally), buys bonds from banks and other financial
institutions, which then reduces interest rates on borrowing from them. This then
encourages the public and businesses to borrow and spend more. Finally jobs are created
and GDP is increased (BBC News, 2015). Therefore, investors have welcomed this measure
by central banks as it makes equities more attractive investments due to it countering
inflation. Also, the rounds of QE have come after significant market declines, signalling a
strong potential for future higher index returns (Sieron, 2014). Thus, in addition to the
already considerable significance regarding the announcement of any policy changes by the
FOMC, QE monetary policy is closely followed by the markets as it determines the returns
on investments; when bond interest rates fall, this encourages investors to switch to
equities to realise a better return on their investments (Big Blue Marble LLC, 2015), (Reilly,
2015).
Previous work on this subject relates to several authors who have studied how central bank
announcements influence asset prices, and these studies range from several different
countries such as Europe as a whole, the United Kingdom and the Unites States of America.
Ranaldo and Rossi (2010) analyse to what extent asset markets- currencies, bonds and the
Swiss stock exchange react to Swiss National Bank communication- encompassing monetary
policy announcements, speeches and interviews. Reeves and Sawicki (2007) examine the
reaction of financial markets to the communication of the Bank of England. In addition to
this, Caglar et al. (within Chadha & Holly (2012) also look at the impact of communication in
the UK on financial instruments, and specifically at how QE influenced prices. A very recent
study by Ricci (2015) studies the impact of announcements made by both the European
Central Bank and the Fed, and this includes the announcements of large-scale-asset-
purchases- QE. Farka & Fleissig (2012) use an information variable to analyse the impact
that it has on asset prices, and they find a significant impact. Positive body language is also
considered and is shown to reduce volatility. There are several other studies which closely
relate to this study, and these will be covered in-depth in the following section. The current
literature helps to highlight the significant effect that central bank communication can have
on asset prices, and which areas have not yet been sufficiently addressed.
In order to add to the extant literature, this study has focussed on specific Federal Reserve
announcements relating to QE3/4, and compares this to policy-rate guidance as well as
interest rate communication. These factors appear to have a significant importance within
the literature, as they greatly influence the confidence level of the market. An example of
this relates to the potential termination of the quantitative easing stimulus in the US, which
initially caused an adverse reaction in equities before Fed officials assured investors by
affirming that further QE would be implemented if necessary (Sieron, 2014). Other factors
will also be considered such as the size and sector of the stocks involved in the analysis. This
includes the three rounds of QE that were undertaken by the central bank in the US
between 2008 and 2014, with the first two already analysed within the literature. This is
arguably an important contribution as it adds specific insight into the effectiveness of
6. 6
central bank communication on the markets, and how it instils confidence into investors
when it is desperately needed after a severe crisis. Furthermore, the main hypothesis of this
paper is to evaluate the effect of “QE3” on S&P 500 stocks- something which appears to
have yet been analysed in the literature- and so this will be tested using data analysis, with
two research questions being analysed through the literature.
Therefore, the main research questions that will be tested are:
RQ1: did policy rate guidance/communication have a statistically significant effect on US
equity stock price returns on the day of the announcement.
RQ2: did interest rates have this effect or not.
As well as this, the hypotheses of the study will then be tested. H1 will assess the following:
Ho1: a positive surprise effect from a particular announcement did not induce a positive
return across equities;
Ha1: a positive surprise effect from a particular announcement induced a positive return
across equities.
Subsequently, H2 will assess the equivalent for a negative effect. Finally, H3- the principal
hypothesis- will test the impact of “QE3” announcements specifically on the S&P 500 index
and various stocks within it from different sectors and of various sizes.
The findings of RQ1 and RQ2 should provide a useful background and comparison from
which to extend the analysis of this broad topic on communication effects. This study also
aims to assess what factors contributed to the effect- if any- that QE announcements had on
S&P 500 stock prices through an analysis of Federal Reserve FOMC minutes and the related
stock price data. This will be done using an events-study approach on Microsoft Excel and
SPSS in order to most accurately measure the real-time change in asset prices caused by
central bank communication. This study is carried out on the underlying assumption of the
famous Fama-French Efficient-Market Hypothesis theory (Fama, 1970).
As a result of this approach, there will inevitably be some limitations in the analysis as
reflected by the work of Reeves and Sawicki (2007). For instance, other events that take
place during the days studied may reduce the significance of communication by the Fed.
However, similarly, the use of intraday data can help to mitigate this problem by sharpening
the focus on the effect of specific announcements on prices. In addition, it may still be
difficult to identify the precise timing of the impact on the markets, as overlapping
information may also have an influence on equity prices.
The structure of the paper is as follows: the next chapters will discuss in-depth the literature
surrounding this topic and what analysis has been carried out on the impact of central bank
communication on asset prices. Following on from that, the next section will then outline
7. 7
the methodology utilised to carry out the analysis, ranging from how the data were
collected and why this particular way was chosen, to the limitations of the methods.
Subsequently, Section IV will then present the findings of the analysis, as well as a discussion
on how these results are significant in comparison to the literature review. Finally, the last
section will conclude the thesis with the main findings and highlight possible ideas for future
research on this topic.
8. 8
Literature Review Chapter
In this chapter the principal aim is to widely discuss the extant literature that is closely
related to the topic of this study: central bank communication and how it affects asset
prices- mainly equities. The purpose is to identify which studies have attempted to answer
or in some way relate to the aforementioned research question and hypotheses, to discuss
to what extent there is sufficient evidence to support these and where gaps still exist that
are necessary to examine. There is extensive coverage of policy-rate
guidance/communication and interest rates respectively- in various studies, and the chapter
will firstly identify this relevant literature and evaluate the findings in order to answer the
research questions. “QE3” on the other hand is scarcely covered with respect to its
influence on equity prices in the literature, and so the hypotheses will be addressed in-
depth using the findings of the data analysis in the following sections. There are however
some studies which have discussed and analysed the extent to which large-scale-asset-
purchases, relating to “QE1” and “QE2”, influenced stock prices and other securities in the
US, and thus these will allow for a closely related analysis of H3 by evaluating how much
impact the programmes had on certain asset prices- according to the respective papers.
Efficient-Market Hypothesis
The central theory that relates to this discussion is the Efficient-Market Hypothesis (EMH),
as the response to asset prices to new information reaching the public domain is being
tested. There are several authors- with their analysis being discussed in this chapter- who
are testing what reaction surprise monetary announcements or policies generate on various
securities: Ranaldo and Rossi (2010), Farka and Fleissig (2012) and Chun-Li (2014) among
others. Furthermore, if markets are efficient- according to Fama’s EMH theory (1970), due
to the forward-looking nature of the markets then any expected element of monetary-policy
change should not affect prices as it is already reflected in them (Fawley and Neely,
2014:74-75). Therefore in this respect, the purpose of this review is to evaluate the
exploration of this widely scrutinised theory, and to explain how the literature evaluates it.
RQ1- Policy-rate Guidance and Communication
Firstly with respect to policy-rate guidance by central banks, there is an abundance of
studies that aim to determine how this form of communication has an impact on stock
prices. This type of guidance was used throughout the financial crisis and is still deployed at
present in order to signal commitment from the Fed to investors, as well as to try and instil
a degree of confidence in the market. Campbell et al. (2012) explore this concept to gauge
9. 9
what influence the policy-rate guidance of the Fed had on US Treasury yields, using a
timeframe spanning from March 2009 to June 2011. As this period succeeds the GFC, this
highlights the evident opinion of the Federal Reserve that it was imperative to utilise as
many communication tools as possible at their disposal, so as to be able to provide as much
support and influence to the recovery of asset prices. For example, the FOMC released a
statement announcing that economic conditions were ‘likely to warrant exceptionally low
levels of the federal funds rate for an extended period’ (Federal Open Market Committee,
2009). In addition, Moessner (2014) also explores explicit guidance and its impact on
equities as well as risk measures. It was found that these announcements at the zero lower
bound (the level of long-term interest rate) had a significant effect on US equity prices.
Again this demonstrates the increased importance of unconventional monetary-policy since
the crisis (Moessner, 2014:2139). This is also backed up by the current Chairperson of the
Federal Reserve- Janet Yellen- who affirms that ‘By lowering private-sector expectations of
the future path of short-term rates, this guidance can reduce longer-term interest rates and
also raise asset prices, in turn, stimulating aggregate demand’ (Yellen, 2013).
The purpose of this extant literature is to identify if policy-guidance has achieved this
objective. The author builds on their previous analysis from Moessner (2013a)- where the
policy effect was tested on short to long-term market interest rates, finding a significant
reduction in them- by studying the impact on equities. Moessner controls for the effects of
macroeconomic news in the regressions, which therefore leads to more valid analysis and
results. They focus on new wording being introduced in statements, which allows for the
surprise component of the announcement to be measured and analysed. This paper
evaluates policy announcements in relation to the federal funds rate- the interest rate at
which banks can borrow form one another overnight. However, it does not analyse how
policy-rate guidance related to QE effects on equities, and so it limits the extent to which
the results of the regression can be representative of the aims of this study. On the other
hand it does provide a steady basis from which to progress as a means of identifying how
this guidance can be applicable across various forms of announcements, and demonstrates
that the desired effect of the Fed’s actions is being achieved- to increase asset prices.
Moreover, this analysis covers an extended analysis of LSAPs by taking into account the
effect on prices of announcements related to these, and not just the purchases themselves.
Studies that it builds on are Doh (2010), Gagnon et al. (2011), Kozicki et al. (2011), D’Amico
et al. (2012) and Rosa (2012). These articles look at how the purchases affected bond yields
and interest rates over a long period of time through the injection of liquidity into the
market, whereas Moessner (2014) has identified the considerable significance that
communication can have as well, not just the effect of the presence of additional funds.
In terms of a more generalised approach to communication that is comprised of monetary
policy announcements, interviews and speeches, the literature surrounding this has also
concluded that they lead to a significant price reaction. There are two key papers that
10. 10
examine this concept, with both analysing central banks in different countries. Ranaldo and
Rossi, (2010) use high-frequency data in their analysis of how communication made by the
Swiss central bank (SNB) influences asset prices in its respective country, while Reeves and
Sawicki (2007) study a similar phenomenon with the Bank of England (BoE). Their analysis
makes use of various statements, testimonies by the Fed Chairman at the time- Alan
Greenspan- and speeches, with the model deployed focusing on the surprise element of the
communication.
The former paper references various other authors who have formed the opinion based on
their findings that central bank communication directly influences asset price changes:
Blinder (1998), Woodford (2003) and Bernanke (2004). In addition, by cross-checking news
reactions, they are able to mitigate exogenous factors that can lead to overestimated results.
The findings show that asset markets are affected not only by official policy statements, but
also by interviews and speeches. This leads to their conclusion based on these findings that
“market participants actively monitor and promptly respond to central bank
communication.” (Ranaldo and Rossi, 2010:487). The authors however do highlight that
their results are paradoxical to those of Kohn and Sack (2004) who do not find any affect
from ordinary speeches.
In terms of the methodological limits of Ranaldo and Rossi (2010), the scope of their analysis
is inevitably limited by the number of broadcasting systems at their disposal, as it is
restricted to three newswire companies. Furthermore, there is the issue with possible
overlapping of communication events and thus it is not possible to contribute all of the
apparent influence on asset prices to the applicable announcements. Overall there is sound
evidence that Swiss equity prices are affected by SNB announcements, although there is a
greater impact on bonds and this paper contains no coverage of the US and the Federal
Reserve, which is the primary focus of this dissertation.
This also applies to the latter paper by Reeves and Sawicki, although both papers do benefit
the analysis by being more recent than the US study to which they refer- Kohn and Sack
(2004). This article also uses intraday data to study the impact of communication by the BoE
on asset prices. Like Kohn and Sack, they measure the variance- and not the mean of assets-
due to the inherent difficulty in quantifying the surprise element from announcements.
Their use of intraday data allows the interference of external news to be mitigated. It is in
fact the publication of inflation reports, as well as minutes releases, that are found to have a
significant impact on asset prices- rather than any form of policy guidance. The paper
highlights the problem with deciphering information from speeches and other forms of
general communication, and this is difficult for the empirical tests that are carried out to
reflect.
This article also emphasises the fundamental importance of effective and transparent
communication to the markets by the central bank, as it gives a clearer picture of the
current economic conditions and projections, as well as any future risks that will need to be
11. 11
addressed. They also pay close attention to speeches made by the BoE, as well as minutes
from committees. However these were again found to not have a significant impact on the
variance of asset prices. Kohn and Sack suggest that this may be the case due to the
convoluted nature of them, as the chairperson will often speak about various matters and
not just those directly related to the economy. Their findings also highlight the apparent
significance that market participants attribute to Congressional testimonies made by the
Fed Chairperson, as the same effect on asset prices from parliamentary hearings- the
equivalent- do not find similar results. Lambert (2004) is cited as finding that the language
used in these testimonies in the US also appears to be significant. In line with this, they also
invoke Ehrmann and Fratzscher (2005) who conclude that Bank of England communication
does not appear to have the same influence on asset prices in comparison to both the
Federal Reserve and the European Central Bank (ECB).
Overall while not all of the studies centred around the topic of different forms of
communication and policy guidance by central banks provide the same results, they do
convey the noticeable impact that they can have in different countries and- especially in the
US. The literature contains findings that indicate that various aspects of policy guidance and
communication affect asset, and more specifically, equity prices- the language used, the
unexpected/ surprise element of announcements, how accommodating it is in terms of long
or short-term, and even the particular employed position of the speaker. Although the
results are not as strong for the UK as in the US, the latter variable potentially explains this
as market participants may attribute more significance to communication depending on
who delivers it. It is apparent from the literature that central bank communication appears
to cause statistically significant impacts on asset prices. The communication includes explicit
policy guidance, speeches, interviews, testimonies and specific language used. Therefore,
the key variable in RQ1 is found to have a significant effect on asset prices.
RQ2- Monetary Policy Decisions- Interest Rates
Whereas the influence of communication has only recently become a recognised significant
factor with regard to asset prices, there is a long history of studies and understanding within
the financial markets that interest rates decisions have significant influence on them.
Monetary policy announcements can have considerable effect on both short and long-term
interest rates as shown in the literature, however the impact of an interest rate change is
also substantial. Interest rate changes are of fundamental importance to market
participants- who monitor them very closely- because of the impact they can have on
various assets. They can cause changes in interest margins, the demand for loans, the ability
of debtors to repay, and- specifically to the investors- the rate of return they expect as well
as the value of portfolios held by banks (Ricci, O. (2015). All of this makes it vitally important
that market participants are fully aware of any news related to interest rates, and that is
why they have been shown to greatly influence asset prices, long as well as short-term.
12. 12
According to a large section of the literature, interest rate changes appear to have a notable
effect on asset prices due to the change being unexpected by the market- the surprise
element. Bernanke & Kuttner (2005), Bredin et al. (2007a), Bredin et al. (2007b), Honda &
Kuroki (2006) and Wongswan (2005) have all realised findings which suggest that a positive
interest rate surprise will result in a stock price response, as this implies that the central
bank has access to adverse information not known to the market (Wang et al., 2012:146). In
addition to this, Wang finds that higher volatility levels as well as stock and bond returns are
all apparent when monetary policy announcements are made during recessions, but not in
expansions. The author attributes this to the economic uncertainty that exists during this
period. Therefore, because interest rate effects on asset prices are more significant during
recessions, this makes the analysis all the more important in highlighting the need for an
understanding of monetary policy decisions and announcements. However, the findings of
this paper indicate that it is the communication of the implied information within the
release of monetary policy announcements- and not the rate decisions themselves- that
have the greatest influence on the stock market. According to Wang, this information
relates to the expected equity premium and future corporate cash flows that are contained
within the statements.
Contrary to this, the paper by Farka (2009) finds that a 1% increase in central bank interest
rates induces considerable stock returns- around 5.6%. The paper attempts to control for
endogeneity and omitted variable biases (OVB), and without these extra measures taken,
previous analysis only showed a decrease of between 2.5 and 4%. These findings provide
strong evidence that interest rate changes- particularly increases- can have a substantial
effect on the stock market while other external news is controlled for. The results are
obtained using high-frequency analysis of changes in S&P 500 and federal funds futures
when monetary policy is announced. Furthermore, the use of intraday data helps with OVB
by reducing the chances of other relevant information being released during the
announcement interval. This builds on previous work that failed to control for these biases
and so provides a sound basis for the results. The findings of Fiordelisi et al. (2014) also find
a statistically significant effect for the Fed unchanging or increasing interest rates, although
there is no statistically significant response from a decrease. Jawadi et al. (2010) also
attribute significant effect to interest rate decisions on asset prices, who study changes in
the 3-month interest rates of the US, UK and French stock markets (p.669). They state that
their results indicate “strong repercussions from interest rate changes on stock markets”,
leading to their conclusion that investors, when making investment decisions, monitor
intervention policies by central banks very carefully.
All of the analysis thus far leads to the conclusion that there are several different factors
that drive asset prices, with regards to monetary policy: the unexpected element of the
announcement, whether the market treats the news as positive or negative, what language
is used, what the actual decisions are in terms of figures, and who delivers the statement.
This conclusion is supported by the work of Chun-Li, (2014) who studies the difference
13. 13
between formative and uninformative FOMC statements: “Thus, on policy announcement
days, market investors monitor closely not only how much of a change the Fed decides on
the interest rate, but also what FOMC statements say.” (Chun-Li, 2014:274). The literature
on interest rates within the subject of monetary policy announcements mostly finds that
announcements of interest rate changes appear to produce a statistical response in asset
prices, with US stock prices often being identified specifically. Therefore, the principal
variable in RQ2 is also found to have a significant effect on asset prices.
Principal Hypothesis- LSAP/QE3 Announcements
This is the final hypothesis which deals with the central aim of the study after covering the
background on the subject of monetary policy announcements. This area provides an
important addition to the analysis because it is adding to the literature by including a focus
on the impact of QE3 announcements on US equity prices. Bernanke and Kuttner (2005)
highlight the significance of the response of stock markets from monetary policy
announcements, as it “exerts a significant impact on financial market conditions and
stability by influencing asset prices and returns” (p.669-670). It is the aim of this section to
identify whether QE1 and QE2 had a similar effect. This will be extensively analysed in the
coming sections, and the studies in the literature that have focussed on the effects of QE1
and QE2- in addition to LSAPs in different countries- will now be examined.
D’Amico et al. (2012) focus on why QE was implemented and what effect it had on market
prices. Their conclusion was that, in terms of yields, QE1 reduced longer term rates by
roughly 35 basis points, while QE2 reduced them by around 45 basis points. Although this
illustrates the desired effect of the programmes by reducing yields and therefore
encouraging equity investment, it does not cover what effect it had on equities, nor does it
explain what the intraday effect of the actual announcement of the programme was on
asset prices.
On the other hand, Fiordelisi et al. (2014) specifically compare conventional and non-
conventional monetary policy interventions to try and gauge to what extent markets react
to them differently. Using an event study approach and covering the period between 2007
and 2012, they find that non-conventional methods appear to produce a stronger reaction
on equity indices than conventional measures. They also find that a reduction or end to
monetary easing does not appear to produce a statistically significant reaction in the US
stock market, although expansionary measures do produce this after three days. In addition,
restrictive measures and policy inaction lead to the opposite effect, which is consistent with
the expectations of the authors. In terms of possible limitations- as pointed out by the
authors- the analysis consists of a limited number of observations and it does not address
spill–over effects, nor does it analyse other types of policy in addition to monetary.
14. 14
Furthermore, Ricci, (2015) also makes use of an events study methodology in order to
measure the cumulative abnormal returns (CARs) of banks’ stock prices around the time of
announcements of the ECB, with a similar period analysed between 2007 and 2013.
Regression analysis is then used in order to determine the cause of these CARs. The findings
of this study also indicate that the stock prices respond greater to non-
standard/unconventional measures than they do to standard measures- interest rate
decisions in this case. Again this infers that monetary policy of this nature- unconventional-
such as QE has a significant impact on asset prices, and in particular stocks, because of the
potential benefits that it brings for equity investors. It thus highlights the important effect of
confidence within the financial markets and this is pivotal to understanding how asset prices
change. Other than psychologically, the tangible effects are also very evident as monetary
policy interventions have provided stability to the financial system (Fiordelisi et al.,
2014:245).
While several recent studies prior to this paper have dealt with the impact of monetary
policy interventions on bank stock returns- Yin et al., 2010), Yin and Yang (2013) and Kim et
al. (2013)- none of them has analysed the financial crisis and the Eurozone crisis period
(Fiordelisi et al., 2014:245). This is a significant contribution to the analysis by adding to the
literature in this way. Moreover, a significant insight is made, in that empirical evidence
suggests that banks that are perceived as being riskier by market participants are more
sensitive to monetary policy decisions.
Overall the results show that the stock prices reacted the most- and in an adverse way- to
announcements signalling an end to or a reduction of monetary easing. This evidence is at
odds with the findings of Fiordelisi et al. (2014), suggesting that the form of methods used
to carry out the analysis is pivotal in determining the price reactions. It is likely that the
focus on the Eurozone as opposed to the US and the implementation of a regression
analysis by Ricci were the main determinants of paradoxical results for monetary easing
effects. Nevertheless, it does provide some useful insight by recognising that often the
country of study- in addition to the methods- can produce significantly different results. The
analysis that will be carried out in this dissertation will also study the effects of the
announcement of the monetary easing programmes being implemented, as this can be
compared with the effect of the reduction/end announcement.
The author also finds that banks with low levels of liquidity and market capitalisation rely
more heavily on monetary policy decisions. Comparing this to FOMC minutes releases,
Jubinski and Tomljanovich (2013) find that it is larger firms which are more sensitive.
Additionally, the stock price of companies that are in more capital intensive and consumer
focused industries respond more. These findings can be compared with the results of the
analysis in the relevant section of this study.
The limitations of these results are also very similar to those of Fiordelisi et al. (2014) in that
they concede that the method used was simplistic, as well as being restricted to a limited
15. 15
number of observations. Furthermore, due to a similar period analysed, the high frequency
of policy interventions during these years resulted in a lot of overlapping of announcements.
Although this is mitigated by the use of an events study methodology with high-frequency
data, there is still a confounding effect.
In addition to this, an analysis of QE effects specific to the UK is analysed by Chadha and
Holly (2012) where they also deploy an events study. They do so with a similar approach to
Bernanke et al. (2004) and Joyce et al. (2010) by studying several variables over several QE
announcements. The said announcements include statements of the quantity of the LSAPs
and also several extensions of the QE programme.
Their results found that over the 6 events studied, investment grade corporate bond yields
fell by 69 basis points where as non-investment grade ones fell by 146 basis points. Most of
the change was as a result of the announcements that contained new information, as
opposed to the generally anticipated ones. The disparity between the two types of yields
can possibly highlight the difference in the sensitivity levels of investment and non-
investment grade bonds, as the latter will be viewed by market participants as carrying
considerably more risk due to their higher risk of default. In contrast to this, the equity
markets- represented by the FTSE All Share Index- registered almost no response to the first
five announcements. However, the final announcement introduced an element of
uncertainty over how long the purchases would take place, and this caused a 3.4% decline in
the index. These results once again demonstrate the significance of the type of
announcement- whether it is signalling long-term support to the markets or an element of
uncertainty- as this causes market participants to adjust their investments accordingly.
The results of this study in this section cannot be fully representative and accurately
compared to previously discussed findings, as the methodology does not make use of
intraday data. It instead uses two-day windows and therefore may lead to an element of
bias in the results. It does however provide further evidence of the importance attributed to
QE and other monetary policy announcements/decisions by investors, and how this can lead
to substantial change in various asset prices.
Overall, across the three sections of the literature review it has been found that various
forms of communication by central banks are utilised in order to try and provide financial
stability and confidence to financial markets and market participants. The results from the
policy-rate guidance section indicate that the language used, the spokesperson and the
surprise element of the various forms of announcements can greatly impact on asset prices,
and so RQ1 appears to be answered within the literature. This seems to be most prevalent
in the US. The section on interest rate effects also answers RQ2 because it finds that the
announcements of changes in them appear to produce a statistically significant response in
asset prices, and especially in stock prices. The final section on LSAP/QE announcements
finds that stock prices respond greater to unconventional monetary policy measures
compared with standard measures. Also, interventions that scale back or eliminate QE
16. 16
programmes were found to produce a statistically significant impact on banks’ stock prices
within the Eurozone, but not in the US- on a range of stock prices. All of these results firmly
test the EMH and illustrate to what extent the market reacts to new information quickly and
efficiently.
These results allow the following analysis to focus on the QE3 programme- implemented by
the Federal Reserve- to determine what level of effect the announcements of it had on
stock prices in the US. The next section will set out how this research was conducted and
discusses any issues that resulted due to the nature of the study and analysis.
17. 17
Methodology
This section outlines the various steps taken and the general procedure that was adopted in
order to achieve the purpose of this study. In order to do this in an efficient and well-
structured manner, at times a simple approach was adopted; this also seemed appropriate
due to the relatively confined word limit of the dissertation. As a reminder, the purpose of
this research was to provide sufficient evidence to primarily explain the impact that
monetary policy announcements relating to LSAPs have had on equity prices, and why. The
equities analysed consist of various large and small stocks from the New York Stock
Exchange and the Nasdaq Composite.
The general structure of this section will begin with a description of the approach adopted
by the researcher, followed by a description of the main data and resources utilised to carry
out the research. In addition to this, an explanation of the reasoning behind the adopted
approach will be outlined, which will include reasons for rejecting alternative methods and
relating this to the relevant literature. This will lead on to assess the reliability and validity of
the analysis in an effort to justify the appropriateness of the chosen method. Finally, the
inherent limitations of the chosen method of analysis will be discussed, as well as the
additional restrictions that the study encountered.
To begin with, it was necessary to adopt a suitable approach for the study. A deductive style
was chosen as the research was undertaken based on the underlying assumption of the
Efficient Market Hypothesis. The purpose was to develop hypotheses to test the effect of
announcements on asset prices, and then to devise an appropriate research design to test
them. In addition, a quantitative-as opposed to a qualitative- approach was used to test the
hypotheses because the reaction of the equities could be reasonably measured, and this
appeared to be the preferred method in the literature.
Next, the researcher decided to adopt an events study method, as this is used in a number
of studies and so appears to be the most appropriate approach for conducting this research.
With reference to the review of the literature, Fiordelisi et al. (2014), Ricci (2015) and
Chadha and Holly (2012) all make specific reference to choosing an events study
methodology, as this is generally accepted as being the optimal way to measure the
response of asset prices to announcements and thus the impact that they have. Events
studies allow the impact of information reaching security prices to be measured, and this
acts as a test for market efficiency (Kliger and Gurevich (2014:1). This approach tracks the
price of companies that feature in the study, which enables a market-related reaction to be
identified (Kliger and Gurevich (2014:1, 3). Therefore the EMH acts as an underlying
assumption in the analysis.
18. 18
The research design consisted of performing a Z-test on 100 equities and the S&P 500 index,
in order to assess whether or not the difference in returns on announcement days was
significant. The following equations measured this effect:
Z=
X̅−μ0
SE
H0: = ; H1: ;
Where the average daily return change, = the average daily equity return change on
announcement day, n= the number of stocks, S= the standard deviation of .
In order to determine first of all the relevant data that needed to be collected, the
researcher had to identify when the monetary policy announcements relating to QE took
place. This was done by accessing the ‘Board of Governors of the Federal Reserve System’
website, accessed at <http://www.federalreserve.gov/>. An official and comprehensive
account of all of the monetary policy releases by the Federal Reserve is provided here, as
well as the official time and date of each announcement.
Subsequent to this, the database Datastream was utilised as it is an official and reliable
source. This was accessed via the Datastream computers in either the Glasgow University
Library or the Wards Library. The purpose of using this database was to accumulate the daily
prices for the aforementioned equities, and this was done by typing in the appropriate
name and then clicking on “run series”. Datastream provides the advantage of being able to
find data relating to a series, and then instantly transferring this data over to Microsoft Excel,
and so this was the next step taken. The daily data was then analysed by calculating the
return for each equity- compared to the previous day- on each date . Analysis of individual
equities follows the approach of Jubinski and Tomljanovich (2013) who refer to the scant
coverage of Federal Reserve and asset price interaction at this level (p.87).
The next stepped involved the researcher computing the daily returns data of the S&P500 in
Excel in order to measure the standard deviation. The number of days between the first and
last announcement were then totalled, and this allowed for the standard error to be
measured. In addition, SPSS was then used to perform a Chi-Squared test in order to provide
more rigour to the analysis. These methods seemed appropriate based on their relative
simplicity and efficiency, as well as the fact that they could illustrate statistical significance
of the announcements. The researcher also has previous experience of using IBM SPSS
Statistics 22. In addition, both Fiordelisi et al. (2014) and Ricci (2015) find that
unconventional monetary policy announcements have a greater effect on stock prices than
does conventional, such as interest rates.
In terms of alternative methods to analyse the impact of announcements on prices, other
studies in the literature have adopted approaches such as regression analysis,
19. 19
parametric/non-parametric techniques and the use of high-frequency daily data- Ranaldo
and Rossi, (2010), Ricci (2015) and Jubinski and Tomljanovich (2013) respectively. However,
an events study measuring the abnormal return induced by announcements appears to be
the simplest method and mostly what is required. This approach is also a manageable task
for the researcher, given the timeframe under which the dissertation was completed and
also the limitations of their knowledge and comfort level.
In relation to the validity and reliability of the results obtained using these sources, both
provide accuracy- Datastream because it has official data, and Excel because it is a reliable
product used for spread sheet analysis throughout academia. Both were also relatively
straightforward to use, with each also providing a help guide. With the data not being
intraday however, this has limited its validity.
This relates to the final discussion with regards to the limitations of the analysis and data. In
terms of the results being generalizable, there is the issue with accounting for other external
factors. This analysis in different countries can realise significantly different outcomes as a
result of the influence of factors such as a greater emphasis by market participants given to
the spokesperson within the central bank, for example. Furthermore, due to the limited
number of securities analysed, this limits the extent to which the data could be applicable in
other settings, as well as the general validity of the results. This works in tandem with the
problem of bias and confounding due to the possible overlapping of events. This can be
mitigated through the use of high-frequency data as it allows the event window to be
significantly narrowed. However, this form of data proved to be inaccessible for the analysis,
and thus daily data was used instead. The results therefore may not be able to have
measured the full and immediate impact of the announcements on the security prices, and
the data- equity prices- may have been influenced by unrelated market commentary. On the
other hand, it can be disputed that intraday data can focus too much on a specific period of
time and therefore attribute an excessive amount of influence to this particular moment. It
is often the case that a stock price’s closing price can be higher (lower) than it was at the
time of a positive (negative announcement).
In this chapter, the approaches taken to undertake the analysis, the data used and also the
various limitations have all been outlined. The chosen method was to analyse the end-of-
day security prices obtained via Datastream on the Microsoft Excel and SPSS platforms. This
presents both advantages and disadvantages in terms of how easily the analysis was carried
out, as well as the restrictions on the possible validity of the results. The overall conclusion
is that the analysis will provide a series of returns of various security prices caused by the QE
monetary policy announcements, as well as a measure of their statistical significance.
Having said this, external factors will make it difficult to positively evaluate the extent of
their accuracy.
The following section will present and discuss in detail these results, in addition to relating
them to the relevant literature to assess their significance in the wider context.
20. 20
Results and Discussion
The results that measured the effect of the various QE3 related announcements by the
Federal Reserve on asset prices will be presented, along with an in-depth discussion of their
significance and how they compare with the literature. As a reminder, the purpose here is to
quantify and explain this effect, and also to position the relevance of the research
questions/hypothesis contained within the study. Furthermore, analysis of any significant
variation across different types of securities, the disparity between sectors and amongst
large and small equities- measured through market capitalisation- is also included. Each
announcement will be addressed in turn, in addition to an analysis of the relevance and
significance of each research question/hypothesis. The discussion will also relate the
findings to the Efficient Market Hypothesis by explaining how the changes in asset prices act
in accordance with this theory. The section will then conclude with an evaluation of the
extent to which the results could accept the hypotheses and how valid the results appear in
line with the surrounding research on the subject.
Fed Hints at QE3- Positive Surprise Effect (H1)
The first announcement analysed, which took place on the 31st August 2012, again was the
first real indication that the Federal Reserve was considering the possibility of imminently
implementing a further large-scale asset-purchases programme- QE3- whereby they would
purchase mortgage-backed securities from banks.
This announcement relates to the impact that language and signalling effects can have on
the behaviour of market participants. This is because it can establish a sense of support and
stability to the financial markets because the nature of the announcement is positive. The
Fed decided to introduce QE3 in order to encourage banks to lend further, which would
therefore encourage spending. In terms of the reaction of equity prices, the principal
hypothesis of this study expected to find that a positive signal such as this would result in an
increase in equity prices- the greater the money supply, the lower the value of the US Dollar,
and thus equity prices appear less expensive to investors abroad (Amadeo, 2014).
In line with the hypothesis, this indication by Ben Bernanke- the Federal Reserve Chairman
at the time- caused a positive reaction in the three major US indices- the Dow Jones
Industrial Average, the S&P500 and the Nasdaq Composite. In addition, 79 out of the 100
small and large stocks taken into consideration to test the hypothesis exhibited a positive
return at the close on the 31st August 2012. Although the sample size of 100 stocks is
relatively small, it does still demonstrate a significant tendency of prices to react positively
to new information. This is further evidence to illustrate that policy-rate guidance/general
21. 21
communication has a statistically significant effect on equity prices, insofar as it delivers a
sense of certainty to the markets and thus encourages investment in equities. This is
supported further by Amadeo (2012) who identifies that Bernanke adopted a similar
technique used by former Fed Chairman Paul Volcker, whereby he aimed to create
transparency by establishing clear public expectations of how the Fed would act.
Furthermore, these findings are in line with Ranaldo and Rossi, (2010) who also find a
significant reaction to communication by stock prices. They attribute this affect to central
banks openly communicating their intentions, and thus market participants expecting a
greater impact from monetary policy. However, they do also find that the reaction of both
bonds and currencies exceeds that of stocks. Reeves and Sawicki (2007) find that asset
prices are not significantly affected by speeches, although they analyse communication by
the BoE. They concede that the language used in US testimonies is different, and so this can
lead to a contrasting effect, as found by Lambert (2004). As Ehrmann and Fratzscher (2005)
find this variation in effect between the BoE and Fed, it suggests that the findings in this
study are perhaps more in line with other results relating to the central bank In the US.
There are also inevitably going to be limitations in these findings due to the fact that the
study had to settle for using daily and not intraday data
Fed Hints at QE3 Tapering- Negative Surprise Effect (H2)
Contrary to this, there are two testimonies contained within this study which examine how
negative rather than positive signalling can impact on asset prices. The first concerns a
testimony made to Congress by Bernanke on the 22nd May 2013, where he addressed them
on the economic outlook of the Federal Reserve. He indicated a tapering measure that could
be adopted whereby the central bank would scale back its asset purchases should they
continue to observe improvement in the economy. The other announcement relates to a
press conference held by Bernanke on the 19th June on the same year where he reiterated
this potential decision, but made the timing more specific by referring to later in the year.
Both announcements made here had the opposite effect to the previous positive signal by
the Fed on stimulating the economy. Because market participants recognise that a
reduction in the quantity of the asset purchases may reduce the demand for equities, these
two announcements- and in particular the latter- resulted in a significant selloff and series
of negative returns in the stock markets. The testimony in May actually produced the
complete opposite effect to that of the one made in August the previous year, in that 83 out
of the 100 stocks in the study realised negative returns. A few notable stocks in the findings
are Cisco Systems, LG Display and Genworth Financial, which all lost around 3% of their
value at the close of the 22nd May. In addition to this, when Bernanke signalled a more
certain reduction in the bond-buying programme, there was an even more extreme result,
with 95 out of the 100 equities exhibiting a negative response to the announcement. In
22. 22
addition, the S&P 500- acting as a benchmark for the analysis- realised an even steeper
decline than in June, with it dropping roughly 1.39% compared to around 0.83% in May.
So far, the positive reaction by indices and the equities analysed in this study to the
testimony in August and the converse reaction that resulted in the following two
announcements support Ha1 and Ha2. This response is consistent with previous studies
within the literature.
The Implementation of QE3 Tapering
Analysis of the prospect of a reduction in the monetary stimulus programme leads to the
actual announcement by the Federal Reserve that this action will be taken. On the 18th
December 2013, the central bank decided to announce its immediate plans to scale-back its
purchases by $10 billion per month in 2014. This was expected to eventually take place by
market participants as it could not be in effect permanently; however the exact timing of it
had still not been known.
What in fact was generally unwelcomed by investors was an end to the programme
altogether rather than a reduction. As a result, the market actually responded very
positively to this announcement, with the three major indices previously mentioned
realising significant gains at the end of the day’s trading. As well as this, all but 12 of the 100
equities posted positive performances, which highlights the considerable degree to which
the market as a whole was considered as a good investment for the immediate future as a
result of the corresponding Fed action. This overwhelming result shows that it does not
have to be “good news” to positively move the market significantly, in the sense that LSAPs
will physically lower rates and hence encourage equity investment. The decision to reduce
the LSAPs is actually in effect not something that will spur investment in the markets, but
because it is better than a complete termination of the programme and prolongs the
purchases, it is treated by market participants as a reason to invest. This is an interesting
insight and is similar to how investors can often react to earnings announcements of
companies. It is often the case that firms will release statements reporting reduced profits
from the previous quarter or even losses, but because the general market anticipated that
the results would be worse, investors in fact welcome this news and the stock price of the
company experiences significant investment.
From all of the results so far we can see that QE3 appeared to produce its desired effect, as
stock markets reacted well to the programme over the period in which it took place. Equity
prices rose significantly between the end of August 2012 and December 2013, and as is
pointed out in the literature, this was working in tandem with “Operation Twist”. The latter
caused short-term interest rates to rise which then allowed long-term rates to fall, thus
encouraging lending and spending (Heard, 2013). This is a major difference between this
23. 23
programme and the previous rounds of LSAPs, and so this helps to provide a potential
explanation as to why QE3 seemed to significantly drive the stock markets, improve the
economy and lower the unemployment rate considerably. Moreover, confidence and
certainty were drastically hampered as a result of the financial crisis, with aspects of
monetary policy being scrutinised. For example, it is debated that the former Fed Chairman
Alan Greenspan kept interest rates at a low rate for an excessive period of time- cutting the
Federal funds rate from 6.5% at the end of 2000 to 1.75% a year later (Annunziata, 2011:
11). This arguably resulted in excessive investment in the markets, and thus leading to a far
more severe financial crisis. The central bank had to ensure that it made prudent and wise
decisions when setting monetary policy, and by showing attentive effort to do just that,
confidence could be restored and this type of programme would be treated by investors as
reliable and effective. It also demonstrates the paramount importance placed on monetary
policy in the US, with each meeting by the Federal Reserve Board being considered as
having a fundamental effect on asset prices.
In addition to this, these findings thus far contribute important insight into how asset prices
tend to respond to different forms of monetary policy, because this is very often
determined by the several factors and not just the quantity of the stimulus package. This is
cited various times in the literature by studies such as Moessner (2014) who attributes
considerable significance to how communication drives asset prices; Ranaldo and Rossi
(2010) who conclude that investors closely monitor different communication to aid their
trading decisions; and Reeves and Sawicki (2007) who highlight the imperative nature of
central bank transparency. Having stated this, it is inherently difficult to ascertain the exact
effects that monetary policy announcements and various forms of communication can have
on asset prices due to the convoluted nature of the markets. There are many other external
factors that can influence prices, and the nature of what is causing the impact- such as the
subjective opinion of market participants- is difficult to decipher. This can concern aspects
like the importance attributed to who makes the address as discussed in the literature
chapter. It is also complicated to gauge these specific variables and hence know the true
scale of the expectations of the markets in relation to these announcements. Therefore the
results of the analysis thus far have to be considered in their wider context as one aspect of
further potential insight into how different types of announcements- in the form of QE in
this study- can determine the change in asset prices, and not as a complete explanation.
Completion of QE3 Programme- Interest Rate Effects
In relation to the discussion of the research question on the effect of interest rate changes,
the announcement of the Federal Reserve bringing an official end to the programme on the
29th October 2014 was an event that was anticipated for a considerable length of time. With
this, the market did not respond with much volatility, as there was certainty established on
the plan of action of the Fed for the economy in the immediate future. The central bank
24. 24
explained its interpretation of the current economic conditions of the country, whereby it
perceived that job creation levels and the employment rate had vastly improved. With this
however, it was felt that the housing sector was still quite weak and inflation was yet to rise
to the desired level (Board of Governors of the Federal Reserve System, 2014). Moreover, in
a bid to ensure that a sense of certainty and placidity remained in the markets, Janet Yellen-
the Fed Chairwoman- reaffirmed to investors that the central bank would keep interest
rates basically at zero for a “considerable time” (Robb, 2014).
In comparison to the effect on the 100 equity prices of the announcements up until now,
this decision to end the stimulus programme is a lot less biased towards either a positive or
negative effect. Around 3/5ths of the stocks closed positively on the day of this
announcement, and this could potentially become an overall negative response with a
larger sample.
With these results, the influence of communication on the future level of interest rates can
be measured more accurately. Because the likelihood of a future hike in rates was alluded to
by a certain degree, this may have encouraged a more prudent approach from market
participants as a result of clarification of this stance by the Fed. It is clear from the extant
literature- and specifically from the studies discussed earlier in the dissertation- that
interest rates are considered as fundamentally important by investors in shaping economic
stability. Ricci (2015) explains how they can influence many different factors such as
demand for loans and margin rates, and this inevitably leads investors to monitoring any
related news scrupulously. In addition, Bernanke & Kuttner (2005) as well as several other
authors found a response from stock prices to positive interest rate surprises, and so the
nature of this announcement can contribute to this evaluation. The impact of being in the
midst of a recession has also been found to induce a reaction in various security types
(Wang and Mayes, 2012). However in this particular case, it appears that it may have been
the combination of the promise of continued monetary stimulus- in the form of agency debt
and MBSs reinvestments- that spurred on equity investment (Board of Governors of the
Federal Reserve System, 2014). It is therefore clear that announcements relating to the
outlook of the broader economy and how it may affect interest rates have a significant
impact on the performance of the stock market. On the other hand, it also highlights the
importance of the central bank sticking to its plan of implementing policy when it deems
necessary, and not to make interest rate changes too liberally in response to current
moribund market conditions. This leads onto a comparison between the results of this
announcement and those that actually outline the quantitative details of the stimulus
programme to the market.
25. 25
QE3 Policy Announcements- H3
The final two announcements that were analysed concern the two dates at which QE3 was
implemented. The first one took place on the 13th September 2012, with the second coming
on the 12th December that same year. The aim of this analysis was to test the principal
hypothesis of the study, which once again was to determine whether these QE3
announcements caused a positive or negative response from different types of equities. This
can help to determine what the possible factors behind these results were, with references
to the literature and other commentary on this topic.
The first announcement in September caused a resoundingly positive and upbeat response
from the market, resulting in a statistically significant result. Just eight of the one hundred
stocks turned negative for the day at the close, which strongly suggests that the market
welcomed the implementation of this programme. Juxtaposed to this, the latter decision by
the Federal Reserve to end its programme known as “Operation Twist” (OT), but at the
same time purchase additional agency mortgage-backed securities, caused a much less
positive response. The broader market- represented by the S&P 500 index- crept up very
slightly at the end of the day’s trading, however it followed that by losing value over the
following couple of days. More specifically, the majority of the 100 stocks analysed in this
study realised negative returns compared with the previous close. It could be surmised that
perhaps as a result of the termination of OT- the Fed selling short-term government bonds
and purchasing long-dated Treasuries- the market became slightly cautious due to the
potential consequences of this, despite the increase in QE purchases. As previously stated,
OT arguably facilitated QE3 in providing a greater effect to the economy and therefore
boosting equities more substantially, and so with its removal investors may have viewed this
as slightly negative news. This follows on to an illustration of the returns realised by the 100
equities- grouped into their respective sectors- and the results of the Z-Test.
28. 28
5. Communication
AnnouncementDate
Quantity
Large (%)
10
Small (%)
10
S&P500
500
Ave.Return Ave.Return Return
31st
August2012 0.3205 0.9115 0.5073
13th
September2012 1.6137 0.8617 1.6310
12th
December2012 0.0910 0.2785 0.0448
21st
May 2013 -1.4345 -1.6520 -0.8274
19th
June 2013
18th
December2013
29th
October2014
-1.8944
1.6040
-0.0144
-1.5625
0.0726
-0.2671
-1.3851
1.6648
-0.1385
Ave.Change 0.9961 0.8008 .8856
Pearson Chi-Square: 180.000a
, .000***
Z-Test- 2-sided Significance Test
= 0.9884, = -1.0427, SE= 0.5031
H0: = ; H1: ;
Z=
X̅−μ0
SE
, Z= 0.9884-(-1.0427)
0.9884−(−1.0427 )
0.5031
= 4.0372
Z>1.96, therefore there is statistical significance at the 5% level and the null hypothesis
cannot be accepted.
*** There is a statistically significant relationship between the independent variable (rows)
and the dependent variable (columns) at the 1% level.
29. 29
All of this analysis very much scrutinises the specific effects that monetary policy
announcements can have on equities and other asset prices, and it encourages future
research to compare the different aspects of how announcements are influential. With this,
it is still difficult to discern whether or not QE3 could be identified as the most successful
out of the LSAP programmes, and how much influence can actually be attributed to it in
continuing the bull market run that has been sustained since 2009. What is clear however is
that the programmes appear to have had some form of influence in driving markets-
predominantly upwards- because each time one has been introduced equity prices have
gained a lot of returns. Furthermore, the significantly large moves on the day of related QE
announcements by equities- as seen from the analysis- provides evidence of a considerable
impact and that investors monitor them very carefully.
With regards to a brief sector analysis, there were not many discrepancies on which to
report, but one variation in the general behaviour of the 100 equities refers to the
Consumer Staples (CS) sector. Whereas the other four that were addressed in the analysis
all experienced over 50% of their 20 stocks reacting negatively to the completion of
“Operation Twist” and an extension in the quantity of purchases of QE3, 60% (12/20) of the
CS stocks realised gains. With this finding, it is perhaps possible to deduce that this
particular sector is at least slightly less affected by monetary policy decisions compared to
the other ones analysed. Jubinski and Tomljanovich (2013) note that companies within
sectors/industries that are more susceptible to greater costs of borrowing and
infrastructure costs, for example, are going to experience a more significant impact from
monetary decisions, and thus this sector could be viewed as potentially being less risky in
this regard. This analysis does have its limitations of course however with a small number of
stocks being addressed, but it does still provide some interesting insight.
To conclude this section, the findings of the analysis on the price response of 100 equities to
various QE3/4 monetary policy announcements have been presented. In addition to this, a
brief discussion on any seemingly significant variations amongst different sectors and equity
sizes has also been addressed. The reaction of asset prices to announcements made by
central banks provides the opportunity for the widely credited theory of market efficiency-
created by Eugene Fama and Kenneth French- to be scrutinised. The Efficient Market
Hypothesis maintains that asset prices will react to new information quickly and efficiently,
and that all publicly available information is already embedded into stock prices. The
analysis allowed for this hypothesis to be put into perspective by monitoring the reaction of
equity prices to announcements regarding LSAPs, attempting to decipher whether the
reactions are possibly delayed and whether they seem reasonable given the information
that is already available to investors. The announcements were able to be grouped into
several different categories that are identified within the literature- reactions to what is
considered positive and negative news, the surprise element, interest rate effects and how
these compare with various forms of policy-rate guidance. Overall it appears that positive
surprises or news will generate a statistically significant response from the majority of
30. 30
equities across different sectors and sizes, and the same is apparent for negative
surprises/news. The principal hypotheses of the study were tested and the null for H1, H2
and H3 therefore cannot be accepted because of these findings.
The research could have achieved greater validity and generalisation with a larger number
of equities having been analysed, however due to the arduous and time-consuming style of
analysis adopted for each equity, this proved to be troublesome given the limited time
period in which to complete the dissertation. A future recommendation for further research
would hence be to increase the sample size of equities, in addition to delving into deeper
analysis of the various forms of communication adopted by central banks, how these vary
across different countries and deploying more complex methods of analysis to try and
discern what direct impact communication has on asset prices. This relates to the difficulty
in omitting external biases and identifying the direct impact of announcements on specific
variables, because they often contain information relating to many different factors and
topics.
The final section will conclude the study as a whole by reiterating the main aims of the
research, discussing to what extent they were fulfilled, how the analysis was undertaken
and by addressing the positioning of the topic within its wider context. This will relate the
problem back to the extensive relevant literature, and will also explain how this study has
been able to make a contribution.
31. 31
Conclusion
The purpose of this study was to research the widely recognised phenomenon of how asset
prices are affected by monetary policy statements. Specifically, the main hypothesis was to
test how equity prices responded to several announcements relating to the large-scale-
asset-purchases made by the Federal Reserve between August 2012 and October 2014- the
programme dubbed as “QE3”. This was tested through the expectation that a positive
surprise effect- identified through the apparent sentiment of market participants- from an
announcement would result in a substantial increase in equity prices, and that the reverse
would take place for negative sentiment relating to monetary policy expectations. In
addition to this, the study consisted of two main research questions. The first one aimed to
evaluate the effect that policy-rate guidance- a prominent tool of communication used by
the Fed identified in the literature- has had in the past, and the other addressed the
significance of communication relating to interest rate changes. The dissertation will reach a
definitive end by identifying the principal findings of the study; through a discussion of how
these are significant in the wider context of the topic- relevance to the extant literature; by
stating the restrictions that were encountered when undertaking the research as well as the
extent of the limitations of the conclusions; and finally with a provision of possible
recommendations that can be provided to extend this area or research- perhaps via a PHD
study.
In terms of a descriptive contribution, the researcher desired to establish the significance of
the context of the Global Financial Crisis and how this necessitated a committed and
competent response from central banks around the world. Following the severe global
economic downturn that led to what is regarded as the worst recession since the Great
Depression that began in 1929, it was essential that a sense of certainty and confidence was
regained both in the economy and within the financial system. This would ideally encourage
greater investment, and could arguably be achieved to a significant degree through two
fundamental strategies of central banks: effective monetary policy stimulus; and effective
monetary policy communication.
The impact of monetary policy communication and the policies themselves are thoroughly
explored within the literature; however the recency of the effects of the latter, particularly
in the United States, is lacking. This allowed for this area of research to be examined further
whereby this study could explore these two aspects in detail, and subsequently analyse how
the specific central bank communication which relates to the most recent LSAPs programme
has affected equity prices across different sectors. This allowed for new insight to be gained
into how asset prices can be affected by elements such as unique policy-rate guidance
measures adopted by the Federal Reserve, interest rate announcements/decisions and
through a programme that was different to its predecessors- mainly through its
32. 32
incorporation of “Operation Twist”. The context is unique in that it ranges from the
immediate aftermath of the global recession up to what appears to be a strong recovery,
and so this allows for extensive insight to be gained into how this context influenced many
factors such as specific monetary policy measures and the behaviour of investors.
Through a dataset that identified the key dates of the QE3 programme and the
corresponding data of the 100 equities analysed, the study was able to draw comparisons
relating to these different announcements and across key sectors in the economy. The main
findings concluded that announcements relating to positive surprise or expectation effects
induced a significant positive price reaction in the S&P500 index as a whole, as well as
across the various equities within different sectors. The equivalent was found for negative
surprise /expectation effects. Thus these results demonstrate the considerable significance
of effective monetary policy decisions, the extensive impact that such announcements can
have on markets- especially relating to LSAPs- and how fundamentally important they are
considered to be by market participants when making investment decisions.
The main findings from the literature provided a more general assessment of the impact of
monetary policy announcements, with Ranaldo and Rossi, (2010) reaching the conclusion
that central bank communication significantly influences stock prices, but not clearly stating
the positive or negative effects. Moreover, Reeves and Sawicki (2007) fail to find any
significant impact in their analysis, and this is possibly as a result of their findings being
based on Bank of England communication. The literature suggests that the effect is largely
dependent on the nature of communication by central banks, although in general it is
illustrated that announcements relating to macro-economic data such as interest rates and
LSAPs do have a significant impact on stock as well as other asset prices. This was found by
Blinder (1998), Woodford (2003) and Bernanke (2004) and Bernanke and Kuttner (2005).
Moreover, Ricci (2015) finds that unconventional measures in Europe have a greater impact
on banks’ stock prices than standard measures- interest rates.
With regards to the two research questions that were analysed within the extant literature,
both policy-rate guidance and interest rate decisions/announcements were found to have
produced a significant impact on asset prices. In relation to the former, Campbell et al.
(2012) found a direct impact on US Treasury yields, while Moessner (2014) realised a
significant effect on US equities from the explicit guidance of monetary policy
announcements- when at the zero lower bound. These affects are attributed to various
factors such as the language used in speeches, the spokesperson and the surprise element
of the announcement. As for the impact of interest rates, various studies such as Bredin et
al. (2007a), Bredin et al. (2007b), Honda & Kuroki (2006) all found that a positive interest
rate resulted in a stock price response. In addition, Farka (2009) found that a 1% change in
the central bank interest rate resulted in stock returns of around 5.6%. While it is difficult to
accurately measure the precise impact of these changes and announcements related to
33. 33
them, it appears from the literature that market participants do respond significantly to and
monitor interest rate news closely.
The nature of the analysis allowed for a straightforward events study and Z-Test to be
carried out, where the responses to seven key QE announcements of one hundred equities
were scrutinised. The validity and accuracy of the results are potentially limited by factors
such as the inability to collate intraday data, the sample size of the dataset, and specific
analysis of one type of asset- as well as coming from one particular country. As a result of
these factors, the results found may be misleading in different countries and could be found
to produce slightly different outcomes with a considerably larger sample size. Moreover, it
limits the ability to accurately compare and contrast the different types of effects of
monetary policy communication within the broad topic. Due to the restrictive timeframe in
which to carry out this analysis, the researcher felt that a more comprehensive and complex
approach to measuring the effect of monetary policy announcements may have been too
demanding. Therefore this approach was found to be more manageable, especially given
the extensive amount of literature that has been published on the subject and the various
factors that are necessary to consider.
Once again, given the variety of information and analysis contained within the study of the
impact of monetary policy communication on asset prices, there are many possible areas in
which to extend this coverage. In terms of further study, such as in PHD research, the
researcher could expand the scope of securities analysed by including the effect of QE3/4 on
assets such as various bonds, commodities and futures. An analysis of each of these was
identified within the literature across different studies, and so this could broaden the scope
of the analysis in order to incorporate a more comprehensive spectrum of findings relating
to this topic. As well as this, one could utilise more complex methods such as regression
analysis to measure cumulative abnormal returns, and of course employ intraday data to
mirror the extant literature more closely in order to obtain a more precise measure of the
direct change caused by these announcements.
It is likely that this area of finance will continue to be scrupulously studied in the future, as it
is critical for market participants to gain thorough insight and understanding into a
phenomenon that appears to elicit a significant price reaction within financial markets.
34. 34
Appendix
List of Equities Analysed
Company Symbol
ABEV
ACN
AGN
AIG
ALR
AMGN
AMX
APPL
ARW
AT&T
AUO
AVP
AVX
BAC
BGS
BIG
BIIB
BIO
BKU
BMY
BRO
BT
BUD
C
CHA
CHE
CHL
CIEN
CINF
CL
CNC
CRL
CRWN
CSC
CSCO
CVC
CYH
DF
DIS
EPAM
EPC
FLIR
FTR
GNW
GOOG
GS
GSK
HAE
HLF
HLS
HNT
HSBC
IBM
INGR
INTC
IRM
JNJ
JNPR
JPM
KO
KT
LCI
LFC
LG
LLY
MBT
MDT
MO
MRK
MS
MSFT
NTL
NTT
ORCL
ORI
PB
PEP
PFE
PG
PM
QCOM
REV
SAM
SAP
SFG
TCB
TDS
TEO
TSM
TSS
TSU
TWC
USM
V
VGR
VZ
WBA
WFC
WMT
XRX
35. 35
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