Target interest rate news effects on the Asia pacific financial markets

This thesis is the first study that provides comprehensive empirical evidence on both the impacts of the target interest rate news from the Reserve Bank of Australia (RBA) on the Australian financial markets, and the spillover effects of the target interest rate news from the US Federal Reserves (Fed) and the European Central Bank (ECB) on the Asia Pacific's equity and currency markets. This thesis contributes to the current literature in several ways. First, while there is ample evidence in the literature suggesting that the markets would not react to what is already expected but will react to the news, the current literature on the RBA's target rate effects is still limited to the investigation of the overall announcement impact on the first moment of the Australian market return only. Therefore, this thesis firstly comprehensively investigates the impacts of the unexpected components of the RBA's target rate announcements (or news) on the first two moments of various segments of the Australian financial markets including interest rate changes, the Australian dollar and stock market returns. In so doing, this thesis contributes to the current literature on the impacts of domestic target interest rate news.Second, while the established literature seems to be missing a thorough investigation of the spillover effects of the Fed's and the ECB's news on the Asia Pacific markets, this thesis provides comprehensive evidence on the spillover effects of the Fed's and the ECB's target rate news on both the mean and volatility of the Asia Pacific's stock and currency returns. Furthermore, we not only document the presence of the news spillover effects but also highlight the incremental explanatory power of the target interest rate news in the presence of the indirect effects from the US's and euro area's markets to the Asia-Pacific markets. To this end, this thesis contributes to the literature on spillover effects of foreign target interest rate news.Third, while the literature is silent on how quickly the target interest rate news is absorbed in foreign markets, this thesis takes a step forward and breaks down the daily horizon into the overnight and the intraday horizons. In so doing, the thesis examines the absorption speed of target rate news in the Asia-Pacific markets. This is an important issue because there might be potential for a diverse array of response dynamics across countries due to heterogeneous market developments, nature of monetary policy synchronization, and financial and real integration with the U.S. and the euro area.Specifically, this thesis presents three independent empirical inquiries that contribute to the literature on domestic and spillover effects of the target interest rate news. Chapter 4 provides comprehensive empirical evidence for the impacts of the RBA's target rate news on various segments of the Australian financial markets during the period from 1998 to 2006. We also investigate the spillover effects of the US Fed's news on the Australian financial markets. We show that the RBA's and the Fed's news significantly affect the Australian financial markets in line with a priori expectations. However, while the RBA's news raises volatility in the Australian financial markets, the volatility was significantly lower in all market segments following the Fed's news. The spillover effects of the US Fed's and the ECB's target interest rate news on the mean and the volatility of twelve Asia Pacific's stock markets' returns are examined in Chapter 5, and seven Asia Pacific exchange rates against the US dollar and the euro over the period 1999-2006 are carried out in Chapter 6. The spillover effects on the conditional mean are generally consistent with the literature where a majority of Asia Pacific stock markets shows significant negative returns and a majority of currencies depreciates against the US dollar and the euro in response to the Fed's and the ECB's unexpected rate rises. Furthermore, in response to the two target rate news, the conditional volatility of the Asia Pacific stock markets was higher while the market calming effects have been observed for the currency markets and both the Fed and the ECB news elicit persisting volatility responses. We conjecture that as the ECB's news tends to confirm the Fed's earlier decision, this relationship might help reduce uncertainties in the Asia Pacific currency markets upon the future path of target interest rates from both the Central Banks, which ultimately results in into a lower volatility level. These findings are important not only to the Asia Pacific’s policy makers to help them improve the conduct of monetary policy but also to market participants in designing trading mechanisms as well as risk management strategies in response to both domestic and external interest rate shocks. Furthermore, these findings also shed light on the lead-lag relationship between the Fed and the ECB in making policy decisions. The notion that the ECB follows the Fed in setting its policy is so strong amongst market participants that empirical evidence seems to be crucial. Despite the fact that the ECB's news arrives after the Fed's news, this study provides evidence that the ECB's news has its own merits in the Asia Pacific markets and helps resolve differences in beliefs among market participants