News and Monetary Shocks at a High Frequency: A Simple Approach (International Monetary Fund)

September 2014

KEYWORDS: Hedge Fund Research, High-Frequency Trading

Authors:

IMF

Organizations:
  • IMF

Summary:

Disentangling the relative impacts of economic news and monetary shocks is crucial to understand financial market developments. In this paper, we develop a simple method to untangle these two shocks. We employ a bivariate structural VAR containing (log) equity prices and 10-year bond yields estimated at the daily frequency and identified with sign restrictions. The sign restrictions used are economically intuitive and easy to employ. The basic intuition is as follows: equity prices and bond yields increase following positive economic news; unexpected monetary tightening reduces equity prices and increases bond yields. Specifically: (i) equity prices and bond yields rise/fall as a result of unexpected positive/negative economic news for future economic activity; (ii) equity prices rise/fall and bond yields fall/rise as a result of unexpected monetary loosening/tightening (because of central bank action or market perceptions); and (iii) central banks tighten/loosen monetary policy in response to expectations of stronger/weaker economic activity, i.e., there is a monetary policy reaction function.

 

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