The sources of volatility transmission in the Euro area money market: from longer maturities to the overnight?

Abstract

This article investigates the transmission of volatility from longer maturities to the overnight segment of the Euro area money market. I use nonparametric estimates of the daily variance of swap rates to test for block exogeneity with respect to the overnight. The results suggest that there exists transmission of volatility shocks from the 1-year swap rate to the overnight market. The reform of the operational framework of March 2004 has improved the segmentation of the market, as it has insulated the overnight segment from volatility spillovers stemming from swap rates of up to 6 months of maturity.

Acknowledgements

I am deeply grateful to Stefano Nardelli for all his support, and to the workshop participants at the ECB (in particular Tobias Linzert and Diego Rodriguez-Palenzuela) for their insightful comments. This article was written during an internship provided at the Monetary Policy Stance Division of the ECB, whose kind hospitality is acknowledged.

Notes

¹ECB (2005a, 2006) showed that these modifications have stabilized the volatility of the overnight interest rate.