Equity Market Condition and Monetary Policy Stance in a Markov-switching Model. Tarathip Tangkanjanapas

Transcription

1 Equity Market Condition and Monetary Policy Stance in a Markov-switching Model Tarathip Tangkanjanapas

2 How US monetary policy influences equity market condition both at domestic and international levels, specifically on emerging-asian market? Does monetary policy affect stock market asymmetrically across its regimes? What happened to the studies after US monetary policy reached its zero-lower bound from the Quantitative Measure? Research Abstract Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model

3 Research Agenda 1 Background 2 Literature Reviews and Empirical Studies 3 Methodology 4 Empirical Results and Discussions 5 Introducing: Risk-Taking Channel 6 Consequences of the US Unconventional Monetary Policy Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model

4 Background Influences of US Monetary Policy on Equity Market Condition: Domestic & International Levels

5 MILLIONS Significance of US Equity Market MSCI AC Ex Japan Mkt Cap S&P 500 Mkt Cap MSCI WD Market Cap (Emerging and Developed) S&P 500 Index MSCI AC Ex Jap Index Share of US Equity Market (All securities in primary market) Country Weights in MSCI All Country World Index, Source: Bloomberg World Equity Market is represented by MSCI All Country World Index. (covers 85% of global investable equity assets) US Equity market contributed more than One-third of the world equity market Emphasizes its significant role in the world equity market 0 Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model 5

6 Literature Reviews & Empirical Studies Regime-Switching Models in Stock Returns Linkages between Monetary Policy Stance and Equity Market

7 Stock Market Regimes Identification Markov-switching model A new approach to identify the regimes in equity markets by Hamilton (1989) Capture both abrupt and persisted changes in financial markets. Several studies use the model to identify regimes in the equity markets Bear Market Regime Low-return High variance State in stock returns Bull Market Regime High-return Low variance State in stock returns Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model 7

8 Asymmetric Effects of Monetary Policy over Stock Market Regimes How equity markets response to monetary policy? Policy rate Expansionary Monetary Policy Policy rate Contractionary Monetary Policy Chen (2007) The potential and positive relationship between expansionary monetary policy and stock returns There exists the asymmetric effects of monetary policy on the US stock returns A tightening monetary policy has stronger effects during volatile states of stock market regimes Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model 8

9 Research Methodology Fixed Transition Probability & Multivariate Markov-Switching Model of Stock Returns

10 Fixed-Transition Probability (FTP) Markov-Switching Model of Stock Returns Identification a regime-switching in US stock market: Bull Stage Bear Stage φ L R t = μ st + ε t, 2 ε t ~i. i. d. N 0, σ St s t is a latent dummy variable equaling either 0 and 1 (bull/bear market) A Two-state fixed transition probability Markov process matrix Bull Stage Stay at the bull stage p 00 = P(s t = 0 s t 1 = 0) Bull to Bear Stage p 00 = exp{θ 0} 1 + exp{θ 0 } Bear Stage Bear to Bull Stage p 11 = exp{γ 0} 1 + exp{γ 0 } Stay at the bear stage p 11 = P(s t = 1 s t 1 = 1) Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model 10

11 US Stock Returns Data Monthly returns on the S&P 500 Price Index from 1965M1 to 2014M08 2,000 1, , R t = 100 p t where p t is log(nominal stock price) Real stock returns = Nominal stock returns CPI inflation rate S&P Nominal Stock Returns Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model 11

12 Identification of Bull and Bear Markets 1.0 2, PROB0 S&P Note: cut-off value = 0.5 where P(S t = 0) > 0.5 : Bull-market, P(S t = 0) < 0.5 : Bear-market 1,500 1, Markov-switching model: Allow stock returns to switch between regimes Lower mean & higher variance (bear) Higher mean & lower variance (bull) Time-persistence Bull: months Bear: 6.25 month Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model 12

13 Bear markets in the US stock history corresponding with financial crises have been captured by the Probability 1.0 Markov-switching model : Black Monday 2001: September 11 terrorist 2002: bubble burst in Dotcom/technology 2007: Subprime mortgage crisis in : European sovereign debt crisis Note: The red-shaded areas represent the identified bear market periods corresponding with the economic recession and financial crises. Year Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model 13

14 Linkages of Monetary Policy & Stock Returns Does monetary policy have asymmetric effects on stock returns?

15 Monetary Policy & Stock Returns A Multivariate Markov-Switching Model: R t = μ st + q j=1 2 β st X t j + ε t, ε t ~i. i. d. N 0, σ st where X t is the monetary policy at time t Measure of monetary policy stance: DDF: Changes in Federal Funds Rates Suggested to have the most immediate impact on monetary and financial conditions DDR: Changes in Discount Rates Served as the Federal Reserve Bank s lending facility (discount window) Charged to depository institutions and commercial banks on loans borrowed directly from the Federal Reserve Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model 15

16 Monetary Policy & Stock Returns DFF(%) 4 2 Sub-Sample using two different end points: FF(%) 16 From zero-lower bound monetary policy trend after the financial crisis in July 2007 end-point Before unconventional monetary policy in response to the financial crisis DFF FF Rate Note: The shaded area is the responses of the Federal funds rate regarding the Subprime mortgage financial crisis: ZLB of monetary policy 4 August 2014 end-point Including the results of unconventional monetary policy where the Federal funds target rates reached the zero lower bound level Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model 16

17 Empirical Results & Key Findings Before and After Zero-Lower Bound of US Monetary Policy

18 Before Zero-Lower Bound of US Monetary Policy State-dependent Effects of Monetary Policy Data Range: 1965M M07 Nominal Returns Real Returns DFF (2) DDR (1) DFF (2) DDR (1) 1.01 (0.16) (1.02) (0.31) (2.03) 1.20 (0.17) (0.98) (0.74) (3.67) (0.15) (1.00) (0.31) (1.98) (0.16) (1.04) (0.75) (3.27) *DFF (2) Model is the strongest statistical significant NOTE: The standard errors are entries in parentheses. The dependent variable in this model is the nominal or real stock returns. β 0 = impact of monetary policy in bull market β 1 = impact of monetary policy in bear market An increase in interest instruments (Federal Funds rates) K e y F i n d i n g s : lowers stock returns in both regimes β 1 > β 0 in both nominal and real returns Changes in interest rate (DFF) have a stronger impact during bear market. Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model 18

19 After Zero-Lower Bound of US Monetary Policy State-dependent Effects of Monetary Policy Data Range: 1965M M08 μ (0.18) μ (1.32) β (0.31) β Nominal Returns Real Returns DFF (2) DDR (1) DFF (2) DDR (1) 1.28 (0.19) (1.05) (0.79) (0.16) (1.15) (0.31) (0.16) (0.93) (0.73) 0.57 (2.53) (1.58) (2.30) (2.02) p p *DFF (2) Model is the strongest statistical significant NOTE: The standard errors are entries in parentheses. The dependent variable in this model is the nominal or real stock returns. K e y F i n d i n g s : β 1 > β 0 in both nominal and real returns Changes in interest rate (DFF) have a stronger impact during bear market. β 1,before > β 1,after in nominal and real returns The overall effects of the monetary policy on stock returns regardless of regimes, become less statistically relevant. Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model 19

20 Global Influences of US Monetary Policy on Emerging-Asian Equity Performance International Spillovers Of US Monetary Policy on Emerging-Asian Equity Returns

21 US Monetary Policy and Emerging-Asian Equity Market Measure of Emerging-Asian Equity market: MSCI AC (All Country) Asia ex Japan Index Measures equity market performance of Asia, excluding Japan. Consists of 10 developed and emerging market country indexes in Asia. MSCI AC Ex Jap Index Fed Funds Rate (RHS) % International Spillover-effects Of the US Monetary Policy on Emerging Asian stock market How the US monetary influences the stock market in Emerging-Asian region Address whether there exist the asymmetric effects across regimes of Emerging-Asian stock market Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model 21

22 Empirical Results and Findings: Global Influences of the US Monetary Policy State-dependent Effects Of Monetary Policy Dependent Variable: MSCI Asia AC Ex. Japan Index Before End-point: July 2007 After End-point: August 2014 DFF DDR (1) DFF DDR (1) 1.42 (0.47) 1.39 (0.43) 1.21 (0.39) 1.17 (0.43) (1.51) (1.32) (1.37) (1.32) (2.86) 0.01 (0.12) (2.88) 0.01 (0.12) (5.43) (5.84) (5.05) (5.84) B e f o r e Z L B A contractionary monetary policy lowers Asian stock return in both regimes but its magnitude effect is stronger during bear market regimes. A f t e r Z L B The overall effects of the US monetary policy becomes less relevant and less effective to Asian stock performance after the crisis in 2007 *DFF (2) Model is the strongest statistical significant NOTE: The standard errors are entries in parentheses. Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model 22

23 Tightening US monetary policy stance Lower the stock returns Expansionary US monetary policy stance Increase the stock returns Asymmetric effects on stock markets across regimes The impact of the US monetary policy is stronger in Similar results for both domestic US and Emerging Asian equity markets Conclusions: The US Monetary Policy Stance and Equity Market Condition Bear Market Regime

24 Introducing Risk-Taking Channel of Monetary Policy Underlying Reasons of Empirical Results

25 The Risk-taking Channel of Monetary Policy How monetary policy impacts risk-perception or risk-tolerance in financial markets. VIX VIX Index S&P500 Index S&P500 2,000 1,800 1,600 1,400 1,200 1, Volatility Index (VIX) A popular indicator of Referred to Fear Index in the assets market Measures the Risk Aversion in financial markets. Risk-neutral stock market variance for the US S&P 500 index Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model 25

26 The Risk-taking Channel of Monetary Policy Co-movement of monetary policy & the VIX index Expansionary monetary policy lowers risk volatility (risk-aversion) and increase the risk-tolerance of investors in financial markets Increase the value of stock market Potential linkages between monetary policy stance and excessive risk-taking in financial markets or risk-appetite No extant research shows a solid linkage between monetary policy and risk-perception in equity markets FF Rate VIX Last Price Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model 26

27 Consequences of the US Unconventional Monetary Policy Zero-Lower Bound of Monetary Policy Instrument & Quantitative Easing Measure after the Financial Crisis in 2007

28 However On-going and recurring unconventional monetary policy measures suppress an overall risk-perception Increasing the risk-taking behavior in the equity markets. Domestic and International Influences of US Monetary Policy on Equity Market become less significant in explaining equity market Compared to prior-financial crisis periods Global equity markets are significantly driven by the anticipation of US monetary policy rate hike after the Quantitative Easing measure impeded The US Policy rate hike is likely to be postponed The US Policy rate hike is likely to be carried out Increase the stock returns Lower the stock returns Equity markets are more sensitive to the anticipation of US monetary policy than the actual policy rate after unconventional monetary policy conducted Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model 28

29 Market-conventionally,it is estimated that the FED policy hike will occur in December 2015 FOMC The implied probabilities for FED policy rate hike increases after the Hawkish-statement released after October meeting. 60% FED Policy Hike Implied Probabilities 56% 54% 50% 40% 30% 39% 45% 45% 43% 46% 46% 42% 39% 36% 32% 48% 20% 10% 0% 6% 4% 0% Oct-2015 Meeting Dec-2015 Meeting Jan-2016 Meeting Mar-2016 Meeting 16-Sep 26-Oct (Pre-FOMC) 28-Oct (Post-FOMC) 8-Nov

30 1,700 How FED Policy hike anticipation influences Thai equity market? 5,000 1,600 3,000 1,500 1,000 1,400-1,000 1,300-3,000 1,200 1,100 Net Foreign SET Index (RHS) Thai equity markets is affected from the anticipation of the FED policy rate hike as international capital flow out when investors expect that the FED will expedite the policy rate hike process; resulted in drop in stock returns induced by foreign net sell position. 1,000 1/2014 2/2014 3/2014 4/2014 5/2014 6/2014 7/2014 8/2014 9/ / / /2014 1/2015 2/2015 3/2015 4/2015 5/2015 6/2015 7/2015 8/2015 9/ /2015 Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model 30-5,000-7,000-9,000

31 Q & A

32 Backup Sildes

33 Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model 33 1,800 1,600 1,400 1,200 1, How FED Policy Hike Anticipation Influences Thai Equity Market? Foreign SET Index

34 MILLIONS Significance of US Equity Market US Market Cap World Market Cap US Share (% of World Market Cap) Note: The size of US equity market: Bloomberg US Exchange Market Cap. USD & the size of the world equity market: Bloomberg World Exchange Market Cap. USD 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Share of US Equity Market In over 10-year periods ( ) US Equity market contributed more than One-third of the world equity market Emphasizes the importance and the role of significant player in the world equity market

35 Significance of US Equity Market Other 28% Canada 3% France 3% United Kingdom 7% Country Weights in MSCI All Country World Index Japan 8% United States 51% Source: MSCI All Country World Index Factsheet (April, 2015) Top 10 Constituents in MSCI All Country World Index Country Mkt. Cap (USD Billions) Apple US Microsoft Corp US Exxon Mobil Corp US Johnson & Johnson US General Electric Co US Wells Fargo & Co US Nestle CH Novartis CH JPMorgan Chase & Co US Procter & Gamble Co US Total 3, World Equity Market is represented by MSCI All Country World Index. The index covers 85% of global investable equity assets both developed and emerging markets countries. Index Weights (%)

36 MILLIONS Significance of US Equity Market The US Equity Market Size compared to the World and Emerging-Asian Markets MSCI AC Ex Japan Mkt Cap S&P 500 Index MSCI WD Market Cap (Emerging and Developed) There exists a co-movement between US and Emerging-Asian equity market The US equity market remains the top contributor in the world market though significance faded over time whereas Emerging-Asian Equity market started to rise in size of market capitalization over time - 3/1995 8/1996 Source: 1/1998 Bloomberg 6/ /2000 4/2002 9/2003 2/2005 7/ /2007 5/ /2010 3/2012 8/2013 1/2015

37 MILLIONS Evolvement of Emerging-Asian Equity Market 50 MSCI AC Ex Japan Mkt Cap MSCI WD Market Cap (Emerging and Developed) MSCI AC Ex Jap Index S&P 500 Mkt Cap S&P 500 Index Source: Bloomberg

38 MILLIONS Emerging-Asian Equity Market Indicator MSCI AC (All Country) Asia ex Japan Index Measures equity market performance of Asia, excluding Japan. Consists of 10 developed and emerging market country indexes in Asia. Covers approximately 85% of the free float-adjusted market capitalization in each country China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand. India 8% Other 17% China 30% 7 6 MSCI AC Ex Japan Mkt Cap MSCI AC Ex Jap Index Hong Kong 13% Taiwan 15% South Korea 17% Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model 38

39 US Monetary Policy and MSCI Ex Japan Index Co-movements between MSCI AC Asia ex Japan Index & Federal Funds Rate MSCI AC Ex Jap Index Fed Funds Rate (RHS) % Equity Market Condition & Monetary Policy Stance in a Markov-Switching Model 39