Daniel Buncic

The Impact of ECB Monetary Policy Decisions and Communication on the Yield Curve

We use intraday changes in money market rates to construct indicators of news about monetary policy stemming separately from policy decisions and from official communication of the ECB, and study their impact on the yield curve. We show that communication may lead to substantial revisions in expectations of monetary policy and, at the same time, exert a significant impact on interest rates at longer maturities. Thereby, the maturity response pattern to communication is hump-shaped, while that to policy decisions is downward sloping.

Global Equity Market Volatility Spillovers: A Broader Role for the United States

Rapach et al. (2013) have recently shown that U.S. equity market returns carry valuable information to improve return forecasts in a large cross-section of international equity markets. In this study, we extend the work of Rapach et al. (2013) and examine if U.S. based equity market information can be used to improve realized volatility forecasts in international equity markets. For that purpose, we obtain volatility data for the U.S. and 17 international equity markets from the Oxford Man Institute’s realized library and augment for each foreign equity market the benchmark HAR model with lagged U.S. equity market volatility information. In-sample as well as out-of-sample evaluation results suggest a strong role for U.S. based volatility information. More specifically, apart from standard in-sample tests, which find U.S. volatility information to be highly significant, we show that this information can be used to substantially improve out-of-sample forecasts of realized volatility. Using large out-of-sample evaluation periods containing at least 2500 observations, we find that forecast improvements, as measured by the out-of-sample R2 (relative to a model that does not include U.S. based volatility information), can be as high as 12.83, 10.43 and 9.41 percent for the All Ordinaries, the Euro STOXX 50 and the CAC 40 at the onestep-ahead horizon. Moreover, forecast improvements are highly significant at the one-stepahead horizon for all 17 equity markets that we consider, yielding Clark-West adjusted tstatistics of over 7. We show further that the improvements from including U.S. based volatility information are consistently experienced over the entire out-of-sample period that we consider, and hold for forecast horizons of up to 22 days ahead.

Identification and Estimation Issues in Exponential Smooth Transition Autoregressive Models

Exponential smooth transition autoregressive (ESTAR) models have been widely used in the empirical international finance literature. We show that the exponential function used in ESTAR models is ill-suited as a regime weighting function because of two undesirable properties. The first is that it can be well approximated by a quadratic function in the threshold variable whenever the transition function parameter γ, which governs the shape of the function, is ‘small’. This leads to identification issues with respect to the transition function parameter and the slope vector in ESTAR models. The second is that the exponential function becomes an indicator function over the entire range of the threshold variable, except at the point where the threshold variable is equal to the location parameter µ. This results in a high propensity to spuriously overfit a small number of observations around µ, leading to an ‘outlier fitting effect’ of the exponential function. We show the effect of both of these problems on estimation of ESTAR models by means of an empirical replication of the well known study by Taylor et al. (2001), and an extensive simulation exercise, where we vary the magnitude of the threshold parameter as well as the sample size.

The Term Structure of Interest Rates in an Estimated New Keynesian Policy Model

We jointly estimate a New Keynesian policy model with a Gaussian affine no-arbitrage specification of the term structure of interest rates, and assess how important inflation, output and monetary policy shocks are as sources of fluctuations in interest rates and the term premium. We work with observable pricing factors and utilize the computationally convenient normalization of Joslin et al. (2013b). This allows us to estimate the model without needing to restrict the parameters driving the market prices of risk. Using data for the U.S. from 1962:Q1 to 2014:Q2, we find that inflation and the output gap account for around 80% of the unconditional forecast error variance of bond yields at the short and medium end of the term structure, while monetary policy shocks account for around 20%. Bond yields respond to macroeconomic shocks only gradually, peaking after about 4 quarters. This is due to sizable monetary policy inertia estimates in our model. At the peak of the response, inflation shocks increase bond yields by more than one-to-one, and output shocks by less than one-to-one, which is consistent with a Taylor type monetary policy rule. Our term premium estimate is strongly counter-cyclical and can capture salient features of the term structure that constitute a puzzle in the expectations hypothesis.

Macroeconomic Factors and Equity Premium Predictability

Neely et al. (2014) have recently demonstrated how to efficiently combine information from a set of popular technical indicators together with the standard Goyal and Welch (2008) predictor variables widely used in the equity premium forecasting literature to improve out-of-sample forecasts of the equity premium using a small number of principal components. We show that forecasts of the equity premium can be further improved by, first, incorporating broader macroeconomic data into the information set, second, improving the selection of the most relevant factors and combining the most relevant factors by means of a forecast combination regression, and third, imposing theoretically motivated positivity constraints on the forecasts of the equity premium. We find that in particular our proposed forecast combination approach, which combines forecasts of the most relevant Neely et al. (2014) and macroeconomic factors and further imposes positivity constraints on the equity premium forecasts, generates statistically significant and economically sizeable improvements over the best performing model of Neely et al. (2014).

Measuring the Output Gap in Switzerland with Linear Opinion Pools

We use the recently proposed linear opinion pool methodology of Garratt et al. (2014) to construct real-time ensemble nowcast densities of the output gap for Switzerland over an out-of-sample period from 2003:Q1 to 2015:Q4. The model space consists of a large number of bivariate VAR specifications for inflation and the output gap, with each specification using a different estimate of the output gap, lag order in the VAR, and structural break information. The ensemble nowcast densities for the output gap are constructed by combining the predictive densities of the individual VAR specifications, weighted by their ability to provide accurate density forecasts for inflation. The overall performance of the linear opinion pool is assessed by its real-time output gap nowcasts and by the size of the ex post revisions to the output gap nowcasts. We find that the linear opinion pool does not produce any more accurate density or point forecasts of inflation than a number of simple univariate benchmark models that condition on the same structural break information. Further, the linear opinion pool’s real-time estimate of the output gap is no more robust to ex post re visions than the real-time estimates of the individual univariate output gaps. The fact that Swiss GDP price deflator data are subject to large revisions, complicates the measurement and forecasting of inflation.

The Role of Jumps and Leverage in Forecasting Volatility in International Equity Markets

We analyse the importance of jumps and the leverage effect on forecasts of realized volatility in a large cross-section of 18 international equity markets, using daily realized measures data from the Oxford-Man Realized Library, and two widely employed empirical models for realized volatility that allow for jumps and leverage. Our out-of-sample forecast evaluation results show that the separation of realized volatility into a continuous and a discontinuous (jump) component is important for the S&P 500, but of rather limited value for the remaining 17 international equity markets that we analyse. Only for 6 equity markets are significant and sizable forecast improvements realized at the one-step-ahead horizon, which, nevertheless, deteriorate quickly and abruptly as the prediction horizon increases. The inclusion of the leverage effect, on the other hand, has a much larger impact on all 18 international equity markets. Forecast gains are not only highly significant, but also sizeable, with gains remaining significant for forecast horizons of up to one month ahead.