Working Paper: CEPR ID: DP8154
Authors: Geert Bekaert; Marie Hoerova; Marco Lo Duca
Abstract: We document a strong co-movement between the VIX, the stock market option-based implied volatility, and monetary policy. We decompose the VIX into two components, a proxy for risk aversion and expected stock market volatility ("uncertainty"), and analyze their dynamic interactions with monetary policy in a structural vector autoregressive framework. A lax monetary policy decreases risk aversion after about five months. Monetary authorities react to periods of high uncertainty by easing monetary policy. These results are robust to controlling for business cycle movements. We further investigate channels through which monetary policy may affect risk aversion, e.g., through its effects on broad liquidity measures and credit.
Keywords: business cycle; monetary policy; option implied volatility; risk aversion; stock market volatility; dynamics; uncertainty
JEL Codes: E32; E44; E52; G12; G20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| lax monetary policy (E63) | decrease risk aversion (D81) |
| monetary policy shocks (E39) | variance in risk aversion (D11) |
| high uncertainty (D80) | looser monetary policy stance (E63) |
| risk aversion component of VIX (D81) | business cycle (E32) |