Stock Market Reaction To Policy Interventions

University of Rome III, Italy

Università degli studi della Tuscia

November 18, 2015

Abstract:

We analyze stock price reactions to the announcements of monetary and fiscal policy actions in twelve stock exchanges worldwide. While previous studies analyzed the effect of policy interventions focusing on monetary policy (e.g. Ricci, 2015) or concentrated on a specific type of companies (e.g. banks), our paper focuses on the reaction of stock indices representing the whole stock exchange and indices representing various industries. By estimating abnormal stock reactions around the announcement date of a wide range of policy actions between the 1st June 2007 and 30th June 2012, we show that: 1) Stock industry-indices react to policy interventions in a different manner from that of the broad stock index suggesting the existence of portfolio diversification opportunities; 2) Expansionary monetary actions have a negative effect on stock prices, when sector indices are taken into account; 3) Stock return reacts negatively to restriction measures for general and non-financial sector indices; 4) There is a stronger price reaction to expansionary measures during the first (and the hardest) stage of financial crisis (1st June 2007-14th September 2008).

Stock Market Reaction To Policy Interventions – Introduction

Policymakers have performed a very large number of interventions (both in terms of instruments used and number of actions run) to repair the negative effects of the financial turmoil (Girardone et al., 2013; Matousek et al., 2013). Most of G-20 countries have announced fiscal stimulus measures (Molyneux et al., 2013). According to Prasad et al. (2009), in 2009 the total amount of stimulus in the G-20 was $700 billion (i.e. 1.4% of their combined GDP and 1.1% of world GDP); more than half of the overall stimulus in 2009 was carried out by only three countries: the U.S., China and Japan. In 2010, three of the largest world economies (the U.S., China and Germany) have planned stimulus packages raising an amount between 2% and 3% of their 2008 GDP; France has proposed stimulus packages amounting to only 0.7% of GDP in 2009. Similarly, monetary policy authorities worldwide developed and a launched new “unconventional” forms of monetary support (Alfonso et al., 2011). Most of banking systems received exceptional levels of support: e.g. the total recapitalization and asset relief in European banking from 2008 to 2012 was nearly equal to 1 trillion Euro (i.e. Germany 144 billions Euro, U.K. 123 billions Euro, Spain 88 billions Euro, Ireland 65 billions Euro, Belgium 40 billions Euro, Greece 37 billions Euro, France 26 billions Euro, Netherlands 24 billions Euro, and Italy 6 billions Euro).

Not surprisingly, an increasing number of papers have been investigating the effectiveness of policy responses to the financial crisis. Most of these papers run narrow in scope empirical analyses and focusing on a single policy action and/or a specific market. For example, McAndrews et al. (2008) examines the effectiveness of the Federal Reserve’s Term Auction Facility (TAF) in mitigating liquidity problems in the interbank funding market. Baba and Packer (2009) analyze the effect of the swap lines among Central Banks in reducing the dollar shortage problem. Meaning and Zhu (2011) explore the impact of recent purchases of Treasury securities by the Federal Reserve and the impact of gilts by the Bank of England on government bond yields. Pennathur et al. (2014) examines market reaction to nine U.S. government interventions in response to the crisis in various type of financial institutions (banks, savings and loan associations, insurance companies, and real estate investment trusts) and show that these measures generally produce an increase in risk and a reduction in value. Ricci (2015) analyzes the impact of the ECB monetary policy announcements between June 2007 and June 2013 on the stock price of European banks: the paper shows that European banks were more sensitive to nonconventional measures than to interest rate decisions, and that the same type of intervention may have a different impact depending on the stage of the crisis.

A handful of papers run an empirical analysis of broader scope by assessing the reaction to a large set of policy interventions in a large set of financial markets. Aït-Sahalia et al. (2012) examines the effect of a large range of policy announcements (fiscal and monetary policy, liquidity support, financial sector policy, and ad-hoc bank failures) on the interbank credit and liquidity risk premia in the U.S., the Euro area, the U.K. and Japan between June 2007 and March 2009. The paper shows that policy announcements were usually associated with reductions in the LIBOR–OIS spreads, however there was no one policy action better than others to contain the crisis. Recently, Fiordelisi and Ricci (2015) use a detailed dataset of worldwide policy interventions between June 2007-June 2012 to analyze their effect on stock prices and CDS returns of Global Systematically Important Banks (G-SIBs). Authors show that different policy interventions from governments and central banks have produced diverse market reactions: e.g. stock market participants have generally appreciated monetary policy interventions, whichever direction (restrictive or expansionary) they have taken, in all currency areas. By contrast, failures and bail-outs have generated a strong negative reaction everywhere.