Abstract
We study the correlation between pairs of bond and stock markets in Canada and the United States between January 1998 and December 2009 in the framework of diagonal-BEKK models. Our research question is whether monetary policy actions and communications by the Bank of Canada and the Federal Reserve significantly affect the conditional co-movement of financial markets (i) within Canada and (ii) between Canada and the United States. We find that central bank communication significantly increases the correlation of financial markets within and across the two countries and is particularly important for the correlation of Canadian and US long-term interest rates.
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Notes
Note that our analysis employs a subset of the Hayo et al. (2008) dataset, as we exclude speeches by regional presidents. Previous studies show that speeches by regional presidents do not affect US (Hayo et al. 2008) or Canadian (Hayo and Neuenkirch 2012) financial markets to any substantial degree.
Bloomberg surveys are used to identify surprises that occur during scheduled meetings. For instance, a ‘surprise hike’ can be (i) an unexpected rise in the target rate or (ii) an unchanged target rate when a rate cut was expected. Intermeeting moves are naturally classified as surprises.
Advance gross domestic product, industrial production, and trade balance to capture the business cycle phase; the Institute for Supply Management manufacturing index and the Conference Board consumer confidence rating for producer and consumer confidence; housing starts for real estate effects; nonfarm payroll and the unemployment rate to proxy labour market conditions; retail sales for actual consumption; and the consumer price index and producer price index for inflation.
Real GDP, capacity utilisation rate, current account, and merchandise trade balance to control for business cycle; the Ivey Purchasing Managers Index for producer confidence; housing starts for real estate markets; net change in employment and the unemployment rate to proxy labour market conditions; retail sales for actual consumption; and the consumer price index, industrial product price index, and raw materials price index for inflation.
All our estimated models are stationary, as the following condition is always fulfilled: a 211 + b 211 < 1.
The hypothesis of constant conditional correlations can be rejected (Engle and Sheppard 2001).
To that end, we regress the univariate financial market returns on all variables of interest and use the residuals as filtered series.
Note that estimation of a model covering the whole sample period and including interaction terms for the financial crisis subsample is not feasible within our framework.
Estimation of nested models including lead, contemporaneous, and lagged effects leads to severe convergence problems and is not feasible.
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Beck, MK., Hayo, B. & Neuenkirch, M. Central bank communication and correlation between financial markets: Canada and the United States. Int Econ Econ Policy 10, 277–296 (2013). https://doi.org/10.1007/s10368-012-0211-x
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DOI: https://doi.org/10.1007/s10368-012-0211-x
Keywords
- Bank of Canada
- Central bank communication
- Diagonal-BEKK models
- Dynamic correlations
- Federal Reserve
- Financial markets