The Impact of the 2004 Reform of the Operational Framework of the ECB: Structural GARCH Evidence

Transcription

1 Journal of Finance and Invesmen Analysis, vol., no. 1, 013, ISSN: (prin version), (online) Scienpress Ld, 013 The Impac of he 004 Reform of he Operaional Framework of he ECB: Srucural GARCH Evidence Paolo Zagaglia 1 and Massimilano Marzo Absrac We invesigae he money-marke impac of he reform of he operaional framework of he European Cenral Bank ha ook place in March 004. We esimae a srucural bivariae GARCH model wih he overnigh rae and 1-year swap rae, where idenifying resricions are imposed on he condiional variances. Differenly from previous sudies, we use a measure of srucural correlaion o sudy he linkages beween he shor end and he longer end of he erm srucure of money marke swaps. Our resuls indicae ha he 1-year swap segmen has decoupled from he overnigh rae as he wo raes do no co-vary any longer. JEL classificaion numbers: C, E58 Keywords: money marke, mulivariae GARCH, srucural idenificaion 1 Inroducion In March 004, he European Cenral Bank adoped a reform o is operaional framework for moneary policy. The reform was inroduced for wo reasons. Firs, here was he need o limi he volailiy for he shor mauriies of 1 Deparmen of Economics (Bologna campus) and School of Poliical Science, (Ravenna campus), Universiy of Bologna, paolo.zagaglia@unibo.i Deparmen of Economics, Universiy of Bologna, assimiliano.marzo@unibo.i Aricle Info: Received : December 17, 01. Revised : January 18, 013 Published online : February 15, 013

2 86 The impac of he 004 reform of ECB operaional framework he money marke erm srucure a he end of he mainenance period. The reason is ha his could have blurred he ransmission of moneary policy impulses along he yield curve. Second, o comply wih he principle of neuraliy of liquidiy policy, here was a case for limiing he volailiy spillovers from he shorer o he long end of he money marke curve (see ECB, 005b). 3 In order o preven excessive bidding from aking place during he main refinancing operaions, he Governing Council decided o change he iming of he reserve mainenance period, and o shoren he mauriy of he main refinancing operaions o one week. A number of conribuions have invesigaed he impac of he 004 reform. The ECB (005a, 006) argues ha he reform has conribued o reducing he average volailiy of he overnigh ineres rae. Durré and Nardelli (008) focus on he role of volailiy spillovers. They use esimaes of realized variance o show ha exogenous shocks o he volailiy of he Euro Overnigh Index Average (EONIA) rae have no impac on he volailiy of he money marke raes a longer mauriies afer March 004. This suggess ha he liquidiy managemen does no affec he ransmission mechanism along he money-marke yield curve. In his paper, we measure money marke segmenaion by sudying he correlaion of he raes a he wo exremes of he mauriy profile. In oher words, we invesigae wheher he reform has induced any changes in he correlaion beween he EONIA rae and he 1-year Euro money marke swap rae. This merics complemens he informaion obained from looking a he ineracions in volailiy along he erm srucure, and focuses on he join movemens of he raes afer a shock. We consider he possibiliy ha shocks o he 1-year swap rae can have an impac on he overnigh rae, and vice versa. 4 This view is relevan under he assumpion ha banks operae sysemaically and conemporaneously in differen segmens of he money marke. For insance, banks could use money-marke insrumens a differen mauriies o hedge over liquidiy needs, or o minimize he coss of raising funds over a given horizon. As a resul, he perspecive considered in his paper differs considerably from he sandard view of 3 Before he implemenaion of he changes, he reserve mainenance period for privae banks sared on he 4h of each monh and ended on he 3rd of he following monh. The duraion of he mainenance period was se independenly from he daes of he Governing Council meeing. Also, he mauriy of he weekly main refinancing operaion was wo weeks. Given ha he enders were conduced a fixed raes, when he marke expeced an increase in he key policy raes, banks submied high bids (overbidding). In oher words, banks ended o absorb liquidiy before he expeced increase in cos would maerialise. When here were expecaions of ineres-rae reducions insead, he bids submied fell shor of he amouns needed o saisfy he reserve requiremens (underbidding). 4 Differenly from Zagaglia (010), however, in his paper we focus on he level of he raes, and no on heir volailiy.

3 P. Zagaglia and M. Marzo 87 he money marke, which ends o overlook a he linkages beween he very shor and he long-erm pars of he marke. Sandard measures of ime-varying correlaion suffer from an endogeneiy problem as hey do no allow o disinguish he mechanisms of shock ransmission from heir exogenous source. To deal wih his issue, we esimae a bivariae GARCH model for he EONIA and he 1-year swap wih idenifying resricions imposed on he covariance marix. The srucural momens disenangle he effecs of exogenous shocks from he endogenous response. The reduced-form momens, insead, embed all he marke linkages and do no address he idenificaion problem. Idenificaion hrough heeroskedasiciy has been applied successfully by Rigobon and Sachs (003b, 004) o sudy he relaion beween moneary policy, macroeconomic evens and asse prices. The resuls presened in his noe for he very shor and very long mauriy segmens of he Euro area money markes poin ou an aspec of he 004 reform of he operaional framework ha has received lile aenion. The srucural esimaes are far lower han he reduced-form esimaes of correlaion over he enire sample. However he srucural correlaions drop o nearly zero over he subsample afer March 004. These resuls sugges ha he idiosyncraic facors ha drive each par of he marke have enhanced he segmenaion as he raes do no co-vary any longer. This paper is organized as follows. The modelling framework is presened in he following secion. Secion 3 discusses he resuls. In Secion 4, we presen some concluding remarks. The Srucural Mulivariae GARCH Model Le us assume ha he evoluion of he variables can be summarized by a srucural VAR model where marix Ax = ψ +Φ ( L) x + η η is he vecor of srucural shocks, and A is he srucural parameer A 1 a. 1 = a1 1 Direc esimaion of he marix A hrough OLS leads o asympoically-biased esimaes, owing o he endogeneiy of he variables. For he purpose of idenificaion, we assume ha he srucural shocks have a zero mean, are independen, and ha heir variances follow he GARCH process

4 88 The impac of he 004 reform of ECB operaional framework wih h = h h = V( η ) defined as η1 h1 0 ξ1 η = 0 h ξ, ξ N, ξ h = c+γ h +Λ η 1 1 h c η h = h c= η 1= c η 1 The marices Γ and Λ are square wih dimension 3. Their elemens are resriced o be posiive. Since he shocks of he reduced form are a linear combinaion of he srucural shocks, hey also have a condiional variance ha follows a GARCH process. In paricular, H11 1 H 11 1 v1 H 1 = Bc l + Bl Γ ( B ) Bl ( B ) H + Λ v 1 1 H b11 b 1 Bl = bb 11 1 bb. 1 b1 b In his model, he resricions ha yield idenificaion are imposed on he covariance marix of he reduced form. This, in urn, depends on he heeroskedasiciy of he srucural shocks. We should sress ha he formulaion of Rigobon and Sachs (003a) does no guaranee ha variance-covariance marices are posiive-definie, which is a problem ypical of every vecor vech model GARCH. To deal wih his issue, we rely on he BEKK-GARCH model of Engle and Kroner (1995). We assume ha he srucural form innovaions η are disribued according o, h = CC + Gh G + Tη η T, ' ' ' ' where C is a riangular marix whose elemens are all posiive, and G and T are wo parameer marices such ha G 11 and T 11 are consrained o be posiive. Idenificaion of he srucural parameers is achieved hrough resricions on he condiional variance-covariance marix of he reduced form innovaions. We begin wih he OLS esimaes of he reduced-form VAR x= c+ FLx ( ) + v

5 P. Zagaglia and M. Marzo 89 1 wih c A 1 1 = ψ, FL ( ) = AΦ ( L). The erm v = A η indicaes he reduced form innovaions, whose variance-covariance marix is a combinaion of he 1 1 variance-covariance marix of he srucural form innovaions H = A ha, wih H = BCC B + BGh G B + BTη η T B. ' ' ' ' ' ' ' In his formulaion he variance-covariance marix of he reduced form innovaions is a funcion of he srucural innovaions, which we he economerician does no observe. However, we can use he equaliy o represen H in erms of he reduced form innovaions H = BCC B + BGAH A G B + BTAv v AT B. ' ' ' ' ' ' ' ' ' Given he posiive-definieness of H by consrucion, we can esimae he model using sandard maximum likelihood mehods. Summing up, he advanage of he model discussed here is ha he srucural innovaions are correlaed. This inroduces a poin of novely ha has no been considered in previous sudies of he Euro-area money marke. Since we esimae he model on he reurns on money-marke raes a wo differen mauriies, he correlaion assumpion allows us o provide evidence on he exisence of common facors ha link he srucural form innovaions of he wo series. Furhermore, comparing he ime-variaion paern of he srucural and he reduced-form correlaions can provide a flavour of he role of money-marke linkages. 3 Main Resuls The daase consiss of weekly averages of he EONIA and 1-year swap raes, which are ploed in Figure 1. Following he principles of he moneary ransmission mechanism, he raes follow he same average pah. However, hey diverge over he whole sample. During periods of decline, he swap rae drops below he overnigh rae. In periods of hike insead, heir relaive posiion reverses. We esimae he model on he reurns compued as he firs difference of he logarihm. Table 1 repors some sample saisics. The daa display he sandard feaures of financial daa. The large kurosis coefficien is indicaive of non-normaliy. The empirical disribuion appears also skewed. We also invesigae he persisence of he reurns. Since Perron and Ng (1996), i is well known ha he sandard ess for uni roos of Dickey and Fuller (1979) and of Phillips and Perron (1988) suffer from severe size disorions in small samples wih ouliers and wih an undeeced fracional order of inegraion. Hence, o deal properly wih hese issues, we compue four modified es saisics for uni roos proposed by Perron and Ng (001). The auxiliary regressions include only a consan. Table repors he es saisics. All he ess rejec he null of a uni roo

6 90 The impac of he 004 reform of ECB operaional framework a he 5% confidence level. The VAR and BEKK esimaes are lised, respecively, in Table 3 and 4. Two resuls from he plos of srucural variances and he srucural correlaion are worh sressing. Figures and 3 show ha he esimaes of he srucural variances are higher han he reduced-form variances. In oher words, disregarding he linkages beween segmens uncovers higher variabiliy of he raes. Sandard GARCH measures underesimae volailiy due o he fac ha he linkages beween segmens dampen he volailiy of he shocks o he ineres raes. From Figures and 3, one can also noice ha he peaks in he srucural variances ake occur on he same days of he peaks in he srucural condiional variances. This means ha when volailiy is low he shocks in he wo markes are negaively correlaed, while hey are posiively correlaed in periods of high volailiy. This evidence can be due o he fac ha he financial conracs underlying he wo ineres raes are subsiues, so ha a shock o one rae implies an opposie shock o oher rae. Figure 4 compares he reduced-form and he srucural condiional correlaion. The reduced-form correlaion swings beween posiive and negaive values all hroughou he sample. Before he 004 reform of he operaional framework, he average reduced-form correlaion is negaive, whereas i urns close o zero righ afer he reform. This suggess ha shocks on one he yields induces a sysemaic response of he oher yield. As argued earlier, reduced-form correlaions provide no informaion on he join movemens of he raes afer exogenous shocks o eiher yield. In his sense, one should focus on he srucural correlaion. Srucural correlaions are far smaller han reduced-form correlaions. In orher words, being unable o disenangle he role of exogenous shocks generaes an overesimaion of he linkages beween raes. Figure 5 provides an enlarged picure of he srucural correlaion. Before March 004, here are frequen peaks. The srucural correlaion also varies on a scale larger han in he subsequen period. The subsample afer March has a mean of less han one enh he mean of he res of he sample. A -es of equaliy beween he means of he wo subsamples yields a p-value equal o e-9, which suggess ha a saisically-significan fall in he mean has aken place. In oher words, he reform of he ECB operaional framework has insulaed he EONIA segmen from ha of he 1-year swap rae also in erms of correlaion beween he raes. 4 Conclusion This paper sudies he impac of he reform of he ECB operaional framework inroduced in 004. We focus on he segmenaion of he money marke by considering he relaion beween he very-shor end and he longer end of he money marke. In paricular, we esimae a measure of correlaion beween he EONIA rae and he 1-year swap rae ha is srucural, in he sense ha i does no suffer from endogeneiy. For his purpose, we esimae a bivariae GARCH

7 P. Zagaglia and M. Marzo 91 model by imposing srucural resricions on he covariance marix. The empirical resuls uncover an ineresing paern. Considering only he spillovers in volailiy along he erm srucure of he money marke. Following he reform, here is a sudden drop in correlaions. In oher words, he EONIA and he 1-year swap rae sop moving in andem. This suggess ha he 004 reform of he operaional framework has increased he segmenaion of he money marke, regardless of he ransmission of volailiy shocks. The analysis presened in his paper can be exended in several relevan ways. Firs of all, a mulivariae model of he enire mauriy srucure of swap raes could provide he ground for a robusness analysis of our resuls. This would require us o consider a more parsimonious model of GARCH dynamics, such as he sandard Dynamic Condiional Correlaion model. Our findings raise he quesion of why he correlaion beween he shor and he long-end of he swap curve drops in 004. In paricular, i would be imporan o invesigae how he demand for liquidiy changes along he erm srucure. This would obviously relaed o he deerminaion of asse-liabiliy managemen sraegies of banks, and how hese schedule heir demand for loans in he money marke over alernaive planning horizons. References [1] A. Durré and S. Nardelli, Volailiy in he Euro Area Money Marke: Effecs from he Moneary Policy Operaional Framework, Inernaional Journal of Finance and Economics, 13(4), (008). [] European Cenral Bank, The Volailiy of he Overnigh Ineres Rae from a Medium-Term Perspecive, Monhly Bullein, (March, 005), 5-7. [3] European Cenral Bank, The Transmission of Overnigh Ineres Rae Volailiy o Longer-Term Ineres Raes in he Euro Area Money Marke, Monhly Bullein, (Augus, 005), 4-6. [4] European Cenral Bank, The Eurosysem s Operaional Framework and he Volailiy of he Overnigh Ineres Rae, Monhly Bullein, (July, 006), 4-9. [5] European Cenral Bank, Volailiy of he Overnigh Ineres Rae and is Transmission along he Money Marke Yield Curve, Monhly Bullein, (Augus, 006), 6-9. [6] R.F. Engle and K.F. Kroner, Mulivariae Simulaneous Generalized ARCH', Economeric Theory, 11, (1995). [7] P. Perron and S. Ng, Useful Modificaions o Uni Roo Tess wih Dependen Errors and Their Local Asympoic Properies, Review of Economic Sudies, 63, (1996). [8] P.C.B. Phillips, and P. Perron, Tesing for a Uni Roo in Time Series Regression, Biomerika, 75, (1988). [9] R. Rigobon, Idenificaion hrough Heeroskedasiciy, Review of Economics

8 9 The impac of he 004 reform of ECB operaional framework and Saisics, 85(4), (003). [10] R. Rigobon, and B. Sack, Spillovers across U.S. Financial Markes, unpublished manuscrip, MIT Sloan School of Managemen, (003a). [11] R. Rigobon and B. Sack, Measuring he Reacion of Moneary Policy o he Sock Marke, Quarerly Journal of Economics, 118(), (003b). [1] R. Rigobon and B. Sack, The Impac of Moneary Policy on Asse Prices, Journal of Moneary Economics, 51(8), (004. [13] S.E. Said and D.A. Dickey, Tesing for Uni Roos in Auoregressive-Moving Average Models of Unknown Order, Biomerika, 71, (1984). [14] J.D. Sargan, and A. Bhargava, Tesing for Residuals from Leas Squares Regression Being Generaed by Gaussian Random Walk, Economerica, 51, (1983). [15] A. Whie, A Heeroskedasiciy-Consisen Covariance Marix Esimaor and a Direc Tes for Heeroskedasiciy, Economerica, 48, (1980). [16] P. Zagaglia, The Sources of Volailiy Transmission in he Euro area money marke: from longer mauriies o he overnigh?, Applied Financial Economics Leers, 17(9), (010).

9 P. Zagaglia and M. Marzo /4/1999 9/7/1999 9/10/1999 9/1/000 9/4/000 9/7/000 9/10/000 9/1/001 9/4/001 9/7/001 9/10/001 9/1/00 9/4/00 9/7/00 9/10/00 9/1/003 9/4/003 9/7/003 9/10/003 9/1/004 9/4/004 9/7/004 9/10/004 9/1/005 9/4/005 9/7/005 9/10/005 9/1/006 9/4/006 9/7/006 9/10/006 9/1/007 9/4/007 9/7/007 EONIA one-year swap Figure 1: EONIA and 1-year swap rae

10 94 The impac of he 004 reform of ECB operaional framework Reduced-form variance Srucural variance 0.4 inroducion of changes o operaional framework /9/1999 7/9/ /9/1999 1/9/000 4/9/000 7/9/000 10/9/000 1/9/001 4/9/001 7/9/001 10/9/001 1/9/00 4/9/00 7/9/00 10/9/00 1/9/003 4/9/003 7/9/003 10/9/003 1/9/004 4/9/004 7/9/004 10/9/004 1/9/005 4/9/005 7/9/005 10/9/005 1/9/006 4/9/006 7/9/006 10/9/006 1/9/007 4/9/007 Figure : Reduced and srucural-form variance of EONIA rae

11 P. Zagaglia and M. Marzo Reduced-form variance Srucural variance 0. inroducion of changes o operaional framework /9/1999 7/9/ /9/1999 1/9/000 4/9/000 7/9/000 10/9/000 1/9/001 4/9/001 7/9/001 10/9/001 1/9/00 4/9/00 7/9/00 10/9/00 1/9/003 4/9/003 7/9/003 10/9/003 1/9/004 4/9/004 7/9/004 10/9/004 1/9/005 4/9/005 7/9/005 10/9/005 1/9/006 4/9/006 7/9/006 10/9/006 1/9/007 4/9/007 Figure 3: Reduced and srucural-form variance of 1-year swap raes

12 96 The impac of he 004 reform of ECB operaional framework Reduced-form correlaion Srucural form correlaion inroducion of changes o operaional framework /9/1999 7/9/ /9/1999 1/9/000 4/9/000 7/9/000 10/9/000 1/9/001 4/9/001 7/9/001 10/9/001 1/9/00 4/9/00 7/9/00 10/9/00 1/9/003 4/9/003 7/9/003 10/9/003 1/9/004 4/9/004 7/9/004 10/9/004 1/9/005 4/9/005 7/9/005 10/9/005 1/9/006 4/9/006 7/9/006 10/9/006 1/9/007 4/9/007 Figure 4: Reduced and srucural-form correlaion beween EONIA and 1-year swap raes

13 P. Zagaglia and M. Marzo inroducion of changes o operaional framework /9/1999 7/9/ /9/1999 1/9/000 4/9/000 7/9/000 10/9/000 1/9/001 4/9/001 7/9/001 10/9/001 1/9/00 4/9/00 7/9/00 10/9/00 1/9/003 4/9/003 7/9/003 10/9/003 1/9/004 4/9/004 7/9/004 10/9/004 1/9/005 4/9/005 7/9/005 10/9/005 1/9/006 4/9/006 7/9/006 10/9/006 1/9/007 4/9/007 Figure 5: Srucural-form correlaion beween EONIA and 1-year swap raes

14 98 The impac of he 004 reform of ECB operaional framework Table 1: Sample saisics of reurns on EONIA and 1-year swap raes Saisics EONIA rae 1-year rae Mean Minimum Maximum Sandard deviaion Skewness Kurosis Table : Uni-roo ess on he differenced series EONIA 1-year swap MZ α * * MZ * * ADF * * Legend: The auoregressive models include boh a consan and a linear rend. Their order is chosen by minimizing he AIC. (*) rejecion a he 5% level.

15 P. Zagaglia and M. Marzo 99 Table 3: Parameer esimaes of he VAR() model Parameer Esimae saisics EONIA rae ψ Φ (1) Φ () Φ (1) Φ () year swap rae ψ Φ (1) Φ () Φ (1) Φ () Legend: The variables are ordered as EONIA rae and 1-year swap rae. Figures in parenhesis indicae he lag. Figures in subscrip indicae he EONIA 1 and he swap rae.

16 100 The impac of he 004 reform of ECB operaional framework Table 4: Parameer esimaes of he BEKK-GARCH model Parameer Esimae saisics c c c a a g g g g