Working Paper: NBER ID: w8597
Authors: Boyan Jovanovic; Peter L. Rousseau
Abstract: Our paper reports the following two findings: 1) In monthly data, bond purchases by the Fed raise bond prices and reduce bond yields. The residual bond-supply to traders is not fully predictable, and this supply-risk adds between 10 and 40 basis points to the standard deviation of the real interest rate on T-bills. 2) The Fed's open market purchases do not raise stock prices or reduce stock returns. If anything, they raise stock returns. More generally, bonds and stocks do not co-move at high frequencies. To explain these two facts, we model the bond and stock markets as spatially separate or 'segmented'. In the model, bond purchases lower bond rates, but they do not affect stock returns, and this is consistent with both facts.
Keywords: Liquidity Effects; Bond Market; Federal Reserve; Interest Rates; Stock Prices
JEL Codes: E44; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Surprise bond purchases by the Federal Reserve (E58) | Increase in bond prices (G12) |
| Surprise bond purchases by the Federal Reserve (E58) | Decrease in bond yields (E43) |
| Supply risk (Q31) | Standard deviation of real interest rate on T-bills (E43) |
| Surprise bond purchases by the Federal Reserve (E58) | No significant effect on stock prices (G19) |
| Surprise bond purchases by the Federal Reserve (E58) | No reduction in stock returns (G19) |
| Bond supply surprises (G12) | Positive correlation with real T-bill returns (G19) |
| Inflation surprises (E31) | Significant effect on real returns (G19) |