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The Fed's policy decisions and implied volatility

Authors

  • Sami Vähämaa,

    1. Department of Accounting and Finance, University of Vaasa, Vaasa, Finland
    2. Department of Finance, University of Central Florida, Orlando, Florida
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  • Janne Äijö

    Corresponding author
    1. Department of Accounting and Finance, University of Vaasa, Vaasa, Finland
    • Department of Accounting and Finance, University of Vaasa, P.O. Box 700, FI-65101 Vaasa, Finland
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  • We thank an anonymous referee, Michele Lenza, Jussi Nikkinen, and participants at the 14th Annual International Conference on Macroeconomic Analysis and International Finance and the 2010 Multinational Finance Society Conference for valuable comments and suggestions. The authors gratefully acknowledge the support of the Emil Aaltonen Foundation, the Finnish Foundation for Share Promotion, the Foundation for Economic Education, the Marcus Wallenberg Foundation, and Suomen Arvopaperimarkkinoiden Edistämissäätiö.

Abstract

This study examines how the Fed's monetary policy decisions affect the implied volatility of the S&P 500 index. The results show that stock market uncertainty is significantly affected by the Fed's policy decisions. In particular, we find that implied volatility generally decreases after FOMC meetings, while the relationship between target rate surprises and market uncertainty appears positive. However, our results also suggest that the apparent positive relationship between policy surprises and implied volatility is mostly driven by the volatility-reducing effects of negative surprises. We further document that implied volatility is affected by both scheduled and unscheduled policy actions, with the scheduled path surprises having the strongest impact on volatility. Finally, our findings indicate that the impact of monetary policy decisions on implied volatility is more pronounced during periods of expansive policy. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark

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