Testing the dimensionality of policy shocks

• Main Authors: LI, Jia, TODOROV, Viktor, ZHANG, Qiushi.
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2022
• Subjects: Bootstrap; High-frequency data; Macroeconomic announcement; Rank test; Structural identification; Yield curve; Econometrics
• Online Access: https://ink.library.smu.edu.sg/soe_research/2563; https://ink.library.smu.edu.sg/context/soe_research/article/3562/viewcontent/Testing_the_Dimensionality_of_Policy_Shocks.pdf
• Institution: Singapore Management University

This paper provides a nonparametric test for deciding the dimensionality of a policy shock as manifest in the abnormal change in asset returns' stochastic covariance matrix, following the release of a macroeconomic announcement. We use high-frequency data in local windows before and after the event to estimate the covariance jump matrix, and then test its rank. We find a one-factor structure in the covariance jump matrix of the yield curve resulting from the Federal Reserve's monetary policy shocks prior to the 2007-2009 financial crisis. The dimensionality of policy shocks increased afterwards due to the use of unconventional monetary policy tools.