During the financial crisis and the following Eurozone crisis, liquidity in financial markets basically froze and became a problem for the real economy. Therefore, market liquidity became one of the major concerns of the ECB, which applied non-standard measures, e.g. irregular asset purchasing programmes. This paper sheds light on the impact of monetary policy on liquidity levels of the DAX 30 equity index and German 10-year government bonds.
For the following analysis, the monetary policy impacts are estimated using the base money growth rate and EONIA rate, whereas the relative bid-ask spread is employed for measuring liquidity levels. The research method includes literature-based research about common market liquidity theories, a short timeline of important ECB monetary policy decisions, descriptive statistics on liquidity levels and monetary policy variables and a VAR analysis, including variables spreads, returns, volatilities, industrial production and inflation.
The results indicate that a decrease (increase) in stock market liquidity or an increase (decrease) in bondmarket volatility lead to a decrease (increase) of EONIA. Furthermore, decreases (increases) in stock return or industrial production result in a decrease (increase) of EONIA. However, base money growth is positively correlated only to changes in bond market volatility. Overall, the results suggest that the monetary policy decisions by the ECB are influenced by changing market conditions without the ability to forecast liquidity levels.
Table of Contents
1. Introduction
2. Theory
2.1 Market Liquidity
2.2 Stock and Bond Market Liquidity
2.3 Market Liquidity Measures
2.4 Monetary Policy and Market Liquidity
2.5 Monetary Policy Measures
3. Timeline of Monetary Policy Events
4. Empirical Evidence
4.1 Descriptive Statistics on Liquidity Levels
4.2 Descriptive Statistics on ECB Monetary Policy Indictors
4.3 Vector Autoregressive Analysis
5. Conclusion
Objectives & Key Themes
This paper examines the impact of European Central Bank (ECB) monetary policy on the liquidity levels of the German DAX 30 equity market and the German 10-year government bond market, utilizing a Vector Autoregressive (VAR) analysis to explore these interlinkages between 2005 and 2014.
- Theoretical framework of market liquidity and its connection to monetary policy
- Chronology of significant ECB monetary policy decisions and interventions
- Empirical analysis of liquidity trends in German stock and bond markets
- Assessment of the transmission of monetary policy on market volatility and returns
- Evaluation of whether monetary policy effectively forecasts or influences liquidity levels
Excerpt from the Book
2.2 Stock and Bond Market Liquidity
This paper focuses on two types of market liquidity, namely stock and bond market liquidity. Before continuing with the effects of monetary policy, correlations between these two markets should be established. Chordia, Sarkar and Subrahmanyam (2005, p.96) found similarities in both markets, such as timing commonalities: market liquidity is lower on Fridays and around the holidays in both markets. Moreover, liquidity peaks generally from July to September. During crisis periods, spreads tend to be higher, viz. market liquidity is lower.
Furthermore, cross-market dynamics flowing from volatility to liquidity suggest common influences across markets. In detail, “volatility in either market is significantly correlated with spreads in both markets” (Chordia, Sarkar and Subrahmanyam, 2005, p.101).
More empirical evidence about linkages is given by Fleming (1997). He provides a model about the linkages of volatility and market liquidity in the bond and stock market. Indeed, the author found strong connections. Fleming (1997, p. 136) argues that this is due to common information, which comes from events such as announcements of the inflation rate. Consequently, this simultaneously alters the expectations of investors across all markets. Afterwards, traders will adjust their holdings across markets, producing an information spillover, viz. cross-market hedging.
Summary of Chapters
1. Introduction: This chapter highlights the growing concern regarding market liquidity since the 2008 financial crisis and establishes the objective of investigating the relationship between ECB policy and German market liquidity.
2. Theory: This section provides the academic foundation by defining market liquidity, detailing measurement methods like bid-ask spreads, and discussing theoretical interlinkages between monetary policy and market dynamics.
3. Timeline of Monetary Policy Events: This chapter presents a chronological overview of key ECB decisions, such as various refinancing operations and bond purchasing programs, enacted during the financial and Eurozone crises.
4. Empirical Evidence: This section provides descriptive statistics on liquidity and policy indicators, followed by a VAR analysis to empirically test correlations between spreads, volatility, returns, and monetary policy variables.
5. Conclusion: This final chapter synthesizes the research findings, confirming that stock market volatility significantly influences illiquidity, while noting that market conditions often trigger ECB responses rather than the reverse.
Keywords
ECB, Monetary Policy, Market Liquidity, DAX 30, Government Bonds, Bid-Ask Spread, EONIA, Financial Crisis, VAR Analysis, Volatility, Stock Market, Bond Market, Eurozone, Asset Purchasing, Liquidity Spirals
Frequently Asked Questions
What is the core focus of this research?
The research primarily investigates the influence of ECB monetary policy decisions on the liquidity levels of the DAX 30 equity index and German 10-year government bonds.
What are the primary themes discussed?
The study centers on market liquidity theories, the historical timeline of the ECB’s crisis-response measures, and the empirical correlation between monetary policy and market volatility.
What is the main research question or objective?
The objective is to determine how changes in monetary policy variables, such as EONIA and base money growth, impact the liquidity of German financial markets and whether these factors can predict liquidity levels.
Which scientific methodology is employed?
The research utilizes literature-based theoretical review, descriptive statistical analysis, and a Vector Autoregressive (VAR) analysis to examine correlations between endogenous and exogenous variables.
What topics are covered in the main body?
The main body covers market liquidity definitions, stock and bond correlations, a detailed timeline of ECB interventions, and the results of a VAR analysis spanning 2005 to 2014.
Which keywords define this paper?
The key concepts include ECB Monetary Policy, Market Liquidity, DAX 30, German Government Bonds, EONIA, and VAR Analysis.
How does stock market volatility affect market liquidity according to the results?
The results indicate that stock market volatility is a major influencer of illiquidity; when volatility rises due to uncertainty, stock market liquidity tends to dry up.
Does the ECB have the ability to forecast market liquidity levels?
The findings suggest that the ECB cannot effectively forecast liquidity levels; rather, market conditions often shift first, prompting a subsequent reaction from the ECB.
- Citation du texte
- Terence Kappeln (Auteur), 2015, The Impact of ECB Monetary Policy on Stock and Bond Market Liquidity. The Case of Germany, Munich, GRIN Verlag, https://www.grin.com/document/313683
