What does unconventional monetary policy do to stock markets in the euro area?

• Author: Tarek Chebbi
• Date: 01 January 2019
• Published date: 01 January 2019
• DOI: http://doi.org/10.1002/ijfe.1669

RESEARCH ARTICLE

What does unconventional monetary policy do to stock

markets in the euro area?

Tarek Chebbi

Faculty of Economic Sciences and

Management, University of Sousse,

Sousse, Tunisia

Correspondence

Tarek Chebbi, Faculty of Economic

Sciences and Management, University of

Sousse, Sousse 4023, Tunisia.

Email: chebbitarekfsegs@hotmail.fr

JEL Classification: E43; E44; E52; E58

Abstract

This paper investigates the impact of the European Central Bank's unconven-

tional monetary surprises on major European stock markets. Three measures

for surprises are used: (a) the change in domestic 10‐year government bond

yields, (b) the change in the spread between German and Italian (Spanish)

10‐year bond yields, and (c) the change in yields of a safe euro‐denominated

asset, such as German bonds. I show that unconventional monetary policy sur-

prises significantly influence stock returns. For instance, monetary decisions

that cause a decrease in Italian (Spanish) sovereign spread led to an increase

in the stock returns. In addition, I find that a positively surprising shock—a fall

in the domestic bond yield and an increase in German interest rates—leads to

higher stock returns. Finally, sovereign spreads seemed to have larger effects

on stock returns both during crisis and postcrisis years.

KEYWORDS

ECB, EGARCH, monetarysurprises, stock prices

1|INTRODUCTION

There is now a common recognition, as well as growing

supportive evidence, that since the beginning of the

financial crisis in August 2007, there is an increasing

attention paid to the unconventional monetary policies

that have been undertaken by major central banks.

Obviously, the ultimate goal of the non‐standard or

unconventional monetary policy measures that include

forward rate guidance, asset purchases, and programs to

directly support bank lending is to reduce some of the

immediate downside risks, contain the financial turmoil,

and stabilize the global economy. Although these mone-

tary policy measures differ across central banks, there is

no doubt that they have many points in common.

There is a fair amount of research on the effects of the

European Central Bank's (ECB) non‐standard policy

measures on both the real economy and financial asset

prices. Existing contributions to the literature focused

on the transmission of monetary policy in the euro area

through various lenses. For example, Peersman (2011)

and Gambacorta, Hofmann, and Peersman (2014)

investigated the effect of unconventional monetary poli-

cies on macroeconomic variables and found that such

policies increased output and inflation. Beirne et al.

(2011) study the impact of the first covered bond pur-

chase programme on bond markets. The results showed

that this instrument has contributed to a decline on cov-

ered bond spreads, namely, during the first week after

the programme announcement. Abbassi and Linzert

(2012) investigated the impact of ECB's non‐standard

monetary policy measures on interbank rates and found

that it was effective in decreasing Euribor rates by more

than 80 bps. Angelini, Nobili, and Picillo (2011) find that

such measures reduced the long‐term interbank spread

only after the failure of Lehman Brothers. Brunetti, di

Filippo, and Harris (2011) find that the non‐standard

monetary programs lead to higher uncertainty in money

markets. Finally, Papadamou and Sogiakas (2018) find

that the ECB's unconventional monetary policies have

Received: 8 November 2017 Revised: 30 June 2018 Accepted: 9 September 2018

DOI: 10.1002/ijfe.1669

Int J Fin Econ. 2019;24:391–411. © 2018 John Wiley & Sons, Ltd.wileyonlinelibrary.com/journal/ijfe 391

an insignificant or even a negative impact on precious

metal prices.

Several papers have examined the impact of the ECB's

unconventional monetary policies on sovereign bond mar-

kets. For instance, Pattipeilohy, Willem van den End,

Tabbae, Frost, and de Haan (2013) find that the Securities

Market Programme (SMP) reduced bond yields in summer

2011. A similar approach has been applied to study the

effects of SMP purchases of Greek sovereign bonds in May

and June 2010 on yields by Trebesch and Zettelmeyer

(2014). They find that yields associated with bonds that

were bought show a large decrease following the start of

the SMP. However, this impact dissipated within a few

weeks. On the basis of an event study methodology,

Falagiarda, McQuade, and Tirpák (2015) investigated the

response of non‐euroarea sovereign debt markets, namely,

from Central and Eastern Europe to ECB's announcements

of non‐standardmonetary policy measures. Generally,they

show that sovereign bond yields are strongly affected by

ECB monetary policy announcements. Krishnamurthy,

Nagel, and Vissing‐Jorgensen (2014) find that ECB mone-

tary policy lowered sovereign spreads, especially for Italy

and Spanish, which in turn induced a marked increase in

euro area stock prices.Falagiarda and Reitz (2015) find that

the ECB's non‐standard monetary policymeasures substan-

tially reduced the sovereign spreads of stressed euro area

countries (Ireland, Italy, Portugal, and Spain). Particularly,

they highlight the important role of news about the

sovereign bond purchasing programs (SMP and Outright

Monetary Transactions, OMT) and the short‐term sover-

eign bond purchases in affecting the perceived sovereign

risk. Szczerbowicz (2015) find that these programs helped

in reducing longer‐term borrowing costs for both banks

and sovereigns and the largest impact is more pronounced

in periphery euro area countries. Kilponen, Laakkonen,

and Vilmunen (2015) find that the announcement of the

ECB's SMP and OMT significantly decreased the yield

spreads in euro area countries. Using high‐frequency data,

Altavilla, Giannone, and Lenza (2016) show that the OMT

announcementssubstantially reduced theItalian and Span-

ish 2‐year government bond yields.

Several papers have investigated the impact of the sur-

prises associated with the ECB's conventional monetary

decisions on stock markets. The results are mixed. For

instance, Bredin, Hyde, Nitzsche, and Reilly (2009) inves-

tigate via an event study the stock market response to

unexpected changes in the U.K. and euro area monetary

policy rates. The empirical findings document significant

negative responses of U.K. and German markets to the

U.K. monetary policy surprises. The influence of euro

area monetary policy shocks appears insignificant for

both markets. Konrad (2009) reports similar findings

and documents an insignificant impact of monetary

policy surprises in the eurozone on German stock return.

Bohl, Siklos, and Sondermann (2008) find that the Euro-

pean stock markets respond negatively to unexpected

interest rate decisions of the ECB. In particular, an unan-

ticipated 25‐basis‐point hike in the interest rate is associ-

ated with decrease between 1.42 and 2.30% in European

stock market prices. Furthermore, they show that the

markets well anticipated the ECB monetary policy news,

implying that the ECB communicates its monetary policy

with success. Hayo and Niehof (2011) find that ECB mon-

etary policy significantly influences several euro area

stock markets. They show that such policy generates sig-

nificant spillover effects on the British and Swiss financial

markets.

To now, the reactions of euro area stock markets to

unconventional monetary policies by the ECB have

attracted much less attention in the literature. Currently,

there have been only few studies on the impact of mone-

tary policy shocks on stock prices; the results are also

mixed. For instance, Rogers, Scotti, and Wright (2014),

Fratzscher, Lo Duca, and Straub (2014), and more

recently Haitsma, Unalmis, and Haan (2016) find that

the announcements of unconventional monetary policy

by the ECB led to an increase in stock returns. However,

Hosono and Isobe (2014) find that unconventional mone-

tary policy surprises negatively impact the stock returns.

In this paper, I attempt to shed light on the impact of

the ECB non‐standard measures on several European

equity market indices using daily data from May 2009 to

June 2015. The daily frequency allows for a more precise

identification of the impact of unconventional monetary

actions on stock markets. In the literature, the paper clos-

est to mine is Haitsma et al. (2016). The authors document

that unconventional monetary policy surprises as mea-

sured by the Italian sovereign spreads affect the EURO

STOXX 50 index. This work complements to Haitsma

et al. (2016) by using several measures of monetary policy

surprises data and an exponential general autoregressive

conditional heteroskedasticity (EGARCH) model of daily

returns to study the effects of such surprises on major

European stock markets. In contrast, this article controls

the relationship between ECB monetary policy surprises

and European stock markets by using surprises from

foreign policy announcements, namely, large scale asset

purchases (LSAPs) by the Federal Reserve.

As stock indices, I employ data set that consists of four

European indices that include the CAC 40 Index (France),

the CDAX Performance Index (Germany), the FTSE MIB

Index (Italy), and the IBEX 35 Index (Spain). As for the

unanticipated component of the unconventional mone-

tary policy, several papers have attempted to analyse its

effect using survey data from professional forecasters

(Ehrmann & Fratzscher, 2004, Joyce, Lasaosa, Stevens, &

392 CHEBBI