The ability a country's policymaker has in forecasting future economic conditions accurately is of fundamental importance to achieving long-run economic objectives. Recent evidence suggests that in light of increasing globalisation, economies and financial markets have become increasingly integrated, thus, an increase in the understanding of current economic conditions both in and out of the country is needed.
Recent events saw the U.S. Federal Reserve Board continually decreasing Federal Funds Target Rate to save the economy during the 2007 subprime mortgage crisis. As equity prices in the u.s. soared upon announcement, the same response was reflected in equity prices of other countries. This thesis thus considers how a 'surprise' change in u.s. monetary policy action affects the economy overseas, specifically the equity market. The variables of interest considered include the U.S. Federal Funds Target Rate, EFFR, both the u.s. and a foreign country's interest rates, equity prices and exchange rates.
This thesis utilises an SVAR model and a modified version of Hamilton's measure of 'surprise' calculations to investigate the impulse response of equity returns to a 'surprise' change in u.s. monetary policy. The SVAR model advantageously allows our inclusion of endogenous financial and economic variables. Our version of Hamilton's methodology allows us to investigate u.s. monetary policy unanticipated components in periods of high market turbulence. Our results indicate that the 'surprise' component of U.S. monetary policy shock is much larger in periods of high market turbulence. Furthermore, a u.s. monetary policy action affects foreign equity returns at a significantly higher magnitude when the policy action is a 'surprise'. The evidence also suggests that foreign equity returns react more to a 'surprise' change in monetary policy, reporting a significantly high effect on the day of the announcement. These results will help in the implementation of a non-U.S. monetary policy action, increasing the effectiveness of monetary policy decisions in periods of high market turbulence.