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Financial Markets and Monetary Policy

Paper Session

Saturday, Jan. 4, 2020 8:00 AM - 10:00 AM (PDT)

Marriott Marquis, La Costa
Hosted By: Econometric Society
  • Chair: Eric Swanson, University of California-Irvine

A Macroeconomic Model of Equities and Real, Nominal, and Defaultable Debt

Eric Swanson
,
University of California-Irvine

Abstract

I show that a simple, structural New Keynesian model with Epstein-Zin preferences is consistent with a wide variety of asset pricing facts, such as the size and variability of risk premia on equities, real and nominal government bonds, and corporate bonds—the equity premium puzzle, bond premium puzzle, and credit spread puzzle, respectively. I thus show how to unify a variety of asset pricing puzzles from finance into a simple, structural framework. Conversely, I show how to bring standard macroeconomic models into agreement with a wide range of asset pricing facts.

The Greenspan Put

Sandeep Dahiya
,
Georgetown University
Bardia Kamrad
,
Georgetown University
Valerio Poti
,
University College Dublin
Akhtarur Siddique
,
U.S. Office of the Comptroller of the Currency

Abstract

How credible is the widely held belief that the Federal Reserve supports the markets? While this "Greenspan Put" has received much public attention there is little empirical evidence that documents its existence and significance. In this paper, we exploit the time-series variation in the Fed Funds Rate (FFR) to detect and quantify the size of the "Greenspan Put". We find that during the periods when the FFR is below the benchmark implied by the Taylor Rule, traded equity put options are valued significantly lower compared to periods when the FFR is at or above its benchmark. These deviations from the Taylor Rule also create a moral hazard as out of the money call options exhibit higher prices during the period when the FFR is below its Taylor Rule benchmark. Finally, we document that the magnitude of the "Greenspan Put" has declined after the Financial Crisis.

Default Risk and the Pricing of United States Sovereign Bonds

Robert Dittmar
,
University of Michigan
Alex Hsu
,
Georgia Institute of Technology
Guillaume Roussellet
,
McGill University
Peter Simasek
,
Georgia Institute of Technology

Abstract

United States Treasury securities are traditionally viewed in academics and practice as being free of default risk. In principle, nominal outstanding Treasury debt can always be repaid by issuing at currency. The same does not hold true, however, for inflation-indexed debt. This leads the latter to embed lower rate of recovery in case of default. We examine the relative pricing of nominal and inflation-indexed debt in the presence of risk of default. We show empirically that the breakeven inflation between nominal Treasury securities and TIPS is significantly related to the premium paid on U.S. credit default swaps (CDS), controlling for measures of liquidity and slow-moving capital. This evidence motivates us to model the prices of nominal and inflation-protected securities in a no-arbitrage setting. Our model shows that breakeven inflation is related to perceptions of differing rates of recovery in the two markets. The estimated model provides evidence that most of the TIPS mispricing after the crisis can be attributed to the exposure to default risk.

Market-Based Monetary Policy Uncertainty

Michael Bauer
,
Federal Reserve Bank of San Francisco
Aeimit Lakdawala
,
Michigan State University
Philippe Mueller
,
University of Warwick

Abstract

This paper investigates the role of monetary policy uncertainty for the transmission of FOMC actions to financial markets using a novel model-free measure of uncertainty based on derivative prices. We document a systematic pattern in monetary policy uncertainty over the course of the FOMC meeting cycle: On FOMC announcement days uncertainty tends to decline substantially, indicating the resolution of policy uncertainty. This decline is then reversed over the first two weeks of the intermeeting FOMC cycle. Both the level and the changes in uncertainty play an important role for the transmission of monetary policy to financial markets. First, changes in uncertainty have substantial effects on a variety of asset prices that are distinct from the effects of the conventional policy surprise measure. For example, the Fed's forward guidance announcements affected asset prices not only by adjusting the expected policy path but also by changing market-perceived uncertainty about this path. Second, at high levels of uncertainty a monetary policy surprise has only modest effects on asset prices, whereas with low uncertainty the impact is significantly more pronounced.
JEL Classifications
  • E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit