US monetary policy announcements and Irish stock market volatility

Abstract

The influence of foreign monetary policy decisions on the volatility of the Irish stock market is investigated. Specifically, the influence of US monetary policy announcements on the ISEQ is examined. Evidence of the so-called calm before the storm is found, i.e., there appears to be a decline in volatility on the day prior to an FOMC meeting and a subsequent increase in volatility after the results of the FOMC meeting is made known. Also evidence is found to suggest that ISEQ volatility is influenced by surprise changes in US monetary policy. Moreover, US monetary surprises appear to affect Irish stock return volatility asymmetrically with a surprise tightening of US monetary policy leading to an increase in Irish stock return volatility. This paper represents an important step in addressing the issues of spillover identification between the USA and the Irish stock market.

Acknowledgements

The views expressed are our own and do not necessarily reflect the views of the ESCB or the staff of the CBFSAI.

Notes

¹ Gallagher and Twomey (1998) measure the impact of international spillovers on returns and volatility in the Irish stock market.

² Bredin et al. (2004) report findings for the effect of US monetary policy shocks on Irish interbank rates.

³ The leverage effect reflects the fact that a fall in the value of the stock price of a firm causes its debt-equity ratio to rise. The perception by shareholders is that their future cash flows are now more risky.

⁴ Flannery and Protopapadkis (2002) did not investigate asymmetric responses.

⁵ A number of authors such as Bonfim (2003), Kuttner (2001), Poole and Rasche (2000) have used this contract to proxy the unexpected component of monetary policy changes.

⁶ The following two periods are dropped from the sample. The 18 April 2001, which was associated with largest surprise change in the Fed funds rate during the sample period and the 11–17 September 2001 when the US stock market was closed as a result of the terrorist attack. See Bernanke and Kuttner (2005) for a detailed discussion of the data.

⁷ The change is F_t  − F_{t −1}, where t is the day of the policy announcement. The change in the ISEQ index (data taken from Datastream) is calculated as (P_{t +1} − P_t )/P_t , where t is the day of the policy announcement.

⁸ Kuttner (2001) uses the current month contract while Bonfim (2003) uses both the current and one month ahead contract.

⁹ The results for the days of the week dummies are not reported in the results section, but are available from the authors.

¹⁰ This is based on an event study methodology where by focusing on a small window it is hoped to reduce the impact of other factors affecting the results. However, all other variables are measured at a daily frequency for the full sample period.

¹¹ Bernanke and Kuttner (2005) use this to determine their sample in their event study of the effect of US monetary policy changes on US stock returns.

¹² The overall results in all cases, and in particular those for the monetary policy shock, are qualitatively unaffected by excluding the S&P500 from the analysis.

¹³ In addition, we also find that volatility appears to be higher on both Mondays and Fridays. These results are not reported here.

¹⁴ Over the full sample there are 24 unscheduled rate changes.

¹⁵ Connolly and Wang (1998) find that international shocks have a much more significant influence on volatility, rather than stock returns.