Electronic copy available at: http://ssrn.com/abstract=1833622 1 Eurozone Stock Market Reactions to Unexpected ECB Monetary Policy Announcements Jean-Yves Filbien 1 Fabien Labondance 2 Abstract: To examine the Eurozone stock market reactions to European Central Bank (ECB) monetary policy announcement surprises, we study the effect of unexpected changes in the ECB's main refinancing rate on aggregate and sectoral Eurozone equity returns. We also analyse the results according to varying business conditions. We estimate unexpected changes on the basis of the market's expectations released in the financial press just before the monetary policy announcement. Using an event study methodology for the 1999-2008 period, we find that the impact of ECB monetary policy surprise is not significant for Euro- zone stock markets. However, we find a significant stock market reaction around unexpected ECB monetary policy announcements when we account for business conditions and industry effects. JEL Classification: E52, E58, G14 Keys Words: Monetary Policy, Stock Prices, Event Study, ECB 1 Jean-Yves Filbien, Louvain School of Management and FUCaM - Univ. Lille Nord de France - LSMRC, email: jean [email protected], 151 chaussée de Binche 7000 - Mons (Belgium) 2 Fabien Labondance (corresponding author), Louvain School of Management and FUCaM - Université Grenoble II, email: [email protected]We appreciate discussions with the participants of the 2009 Research Network Macroeconomics and Macroeconomic Policies Conference in Berlin; the 2009 Symposium on Money, Banking and Finance in Orléans; and the 2009 New Challenges to Central Banking in the Global Financial System Conference in Namur. We thank Natacha Gilson and Etienne Farvaque for many helpful comments. Remaining errors are ours.
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Electronic copy available at: http://ssrn.com/abstract=1833622
1
Eurozone Stock Market Reactions
to Unexpected ECB Monetary Policy Announcements
Jean-Yves Filbien1
Fabien Labondance2
Abstract:
To examine the Eurozone stock market reactions to European Central Bank (ECB)
monetary policy announcement surprises, we study the effect of unexpected changes in the
ECB's main refinancing rate on aggregate and sectoral Eurozone equity returns. We also
analyse the results according to varying business conditions. We estimate unexpected
changes on the basis of the market's expectations released in the financial press just before
the monetary policy announcement. Using an event study methodology for the 1999-2008
period, we find that the impact of ECB monetary policy surprise is not significant for Euro-
zone stock markets. However, we find a significant stock market reaction around
unexpected ECB monetary policy announcements when we account for business conditions
1 Jean-Yves Filbien, Louvain School of Management and FUCaM - Univ. Lille Nord de France - LSMRC, email: jean [email protected], 151 chaussée de Binche 7000 - Mons (Belgium) 2 Fabien Labondance (corresponding author), Louvain School of Management and FUCaM - Université Grenoble II, email: [email protected] We appreciate discussions with the participants of the 2009 Research Network Macroeconomics and Macroeconomic Policies Conference in Berlin; the 2009 Symposium on Money, Banking and Finance in Orléans; and the 2009 New Challenges to Central Banking in the Global Financial System Conference in Namur. We thank Natacha Gilson and Etienne Farvaque for many helpful comments. Remaining errors are ours.
We define the unexpected component of MRO announcements according to the difference
between European ECB watchers consensus, released in the financial press just before the
ECB Board of Governors' meetings, and the decisions of the ECB (Pearce and Roley, 1983,
1985; Bohl et al., 2008; Gkougkousi and Rossenboom, 2010). We obtain European analysts'
expectations from research published in Financial Times,
Table 1 : Distribution of the Change in ECB Main Refinancing Operations rates
Announcements
This table presents the annual frequency of the change in ECB main refinancing operations rates
announcements between 1999 and 2008
Les Echos, and the La Tribune, using Factiva3. Our estimate of unexpected ECB monetary
announcement includes the sign of the surprise and its degree. The sign of the unexpected
ECB MRO reflects the difference between the sign of the change in the ECB MRO and that
expected by the analysts. The degree of unexpected ECB MRO instead indicates the
3 Factiva is a database providing a world-wide press content.
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difference between the degree of the change in the ECB MRO and that expected by analysts.
For example, on April 4, 1999, the ECB lowered the MRO from 3.00% to 2.50%, whereas
the market expected a decrease of 25 basis points. We therefore identify an unexpected
ECB monetary policy announcement in degree but not in sign.
In Tables 2 and 3, we provide the occurrence matrix of the sign and the degree of
unexpected changes in ECB MRO. We have 17 and 11 unexpected ECB monetary policy
announcements according to the sign and the degree, respectively. Therefore, it appears that
the ECB monetary policy decisions are well anticipated by analysts. In Table 4, we also
present the distribution of the sign and the degree of unexpected ECB MRO over the study
period. We argue that these data imply the ECB has successfully communicated its monetary
policy, especially in the recent years (Rosa and Verga, 2007).
Table 2 : Sign of Unexpected Changes in ECB Main Refinancing Operations
Rates Announcements Matrix
This table presents the frequency of unexpected signs of the ECB main refinancing operations rates
announcements. We present the expected sign of the change in the ECB main refinancing operation rates just
prior to the monetary policy announcement in the columns and the sign of the change in the ECB main
refinancing operation rates in the rows.
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Table 3 : Degree of Unexpected Changes in ECB Main Refinancing Operations
Rates Announcements Matrix
This table presents the frequency of the unexpected degree of the ECB main refinancing operations rates
announcements. We present the expected degree of the change in the ECB main refinancing operation rates
just prior to the monetary policy announcement in the columns and the degree of the change in the ECB main
refinancing operation rates in the rows.
Table 4 : Distribution of Unexpected Changes in ECB Main Refinancing
Operations Rates Announcements
This table presents the annual frequency of the unexpected sign and the degree of the changes in the ECB main
refinancing operations rates announcements.
3.2 Methodology
3.2.1 Stock Prices Indexes
We focus on stock markets because they are among the most liquid asset markets in the
Eurozone. We use daily stock market index prices from Datastream. We study the
Eurozone stock markets with the highest capitalizations, seven domestic stock market
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indexes: the BEL20 Index (Belgium), the OMX Helsinki Index (Finland), the CAC40 Index
(France), the Performance DAX30 Index (Germany), the Milan MIB30
Index (Italy), the AEX Index (The Netherlands), and the IBEX35 Index (Spain); and one
aggregate stock market index, the DJEurostoxx50 Index (Eurozone). We provide descriptive
statistics to better understand the financial environment in which take place the ECB
monetary policy. In Table 5, we present the performance data from 1999 to 2008. Each year,
on average, performance ranges from -4.64% for Italy and 4.58% for Finland, to 0.64% for
France and 1.13% for Germany. From Datastream, we also extract the sectorial
DJEurostoxx index prices.
3.2.2 Event Study Methodology
We calculate the abnormal returns using from the event study methodology introduced by
Fama et al. (1969). Abnormal returns can be estimated with three different models: the
constant mean returns model, the market model, or the adjusted return risk market. The
measure of abnormal returns is robust to the choice of model (Brown and Warner, 1985).
Because of our focus on index returns, we select the mean constant returns model to
estimate the abnormal component of returns of stock market index i at date t:
(1)
with
(2)
where is the abnormal return of the stock market index i at day t, reveals the
observed return of the stock market index i at day t, and indicates the average of returns
of index i over the estimation period. To avoid contamination of the estimation period, we
use an estimation period that spans 400 days to 20 days before the announcement date4. We
calculate the cross-sectional average abnormal return:
4 Our results are robust to the length of the estimation period.
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(3)
Table 5 : Performance of the Eurozone Stock Markets
This table presents the annual percentage returns of the Eurozone stock markets between January 1, 1999, and
December 31, 2008. The average return over the 1999-2008 period is calculated from the geometrical average.
The domestic and aggregate Eurozone stock markets are the BEL20 Index (Belgium), the DJEurostoxx50 Index (Eurozone), the OMX Helsinki Index (Finland), the CAC40 Index (France),
the Performance DAX30 Index (Germany), the Milan MIB30 Index (Italy), the AEX Index (The Netherlands),
and the IBEX35 Index (Spain).
where n indicates the number of announcements in our sample. Then, we calculate the
cumulative abnormal returns by summing the average abnormal returns over the three
trading days surrounding the announcement dates [-1 day; +1 day]:
(4)
This window of three trading days controls for possible news leaks, allows investors time to
gather additional information, and avoids overlapping events. To test for statistical
significance, we control for event-induced variance (Boehmer et al., 1991).
3.2.3 Classification of Business Conditions
Following McQueen and Roley (1993), we use the seasonally adjusted monthly industrial
production index of each country to define their business conditions. First, we estimate a
trend in the log of industrial production on a constant and a time trend from January 1,
1999, to December 31, 2008. Second, we add and subtract a constant from the trend,
creating upper and lower bounds. We choose the constant for each index such that the log
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of industrial production is greater than upper bound, denoted as\high" business activity, 25%
of the time. The log of industrial production is less than the lower bound, indicating \low"
economic activity, about 25% of the time as well. \Medium" economic activity is represented
by the remaining observations between the bounds.
4 Results
We develop the results following the three hypotheses previously mentioned.
4.1 Stock Market Reaction to Unexpected ECB Monetary Policy
Table 6 presents the correlation coeffcients between the returns of the aggregate and
domestic Eurozone stock markets, the ECB MRO, and the European short interest rates.
Not surprisingly, we observe that the aggregate and domestic Eurozone stock market
returns are significatively and strongly correlated. The Eurozone returns index is highly
correlated with the German and French stock markets returns in particular. Moreover, the
European short interest rates and the ECB MRO are significantly and strongly correlated.
Finally, we observe a significant negative correlation between the ECB MRO and the
domestic Eurozone stock markets returns.
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Table 6 : Correlation Matrix
This table presents the correlation coefficients of the returns of the BEL20 Index (Belgium), the DJEurostoxx50 Index (Eurozone), the OMX Helsinki Index (Finland), the
CAC40 Index (France), the Performance DAX30 Index (Germany), the Milan MIB30 Index (Italy), the AEX Index (The Netherlands), and the IBEX35 Index (Spain), as well
as the ECB main refinancing operations rates (MRO) and Euribor 3 months. (***),(**), and (*) indicate the significant results at the 1%, 5% and 10% levels, respectively.
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In Table 7, we present the cumulative abnormal returns according to the sign and the degree
of the unexpected change in the ECB MRO. We expected a negative relationship between
abnormal returns and the sign / degree of the change in the ECB MRO, but our results do
not indicate any evidence of an inverse relationship between the abnormal returns and
unexpected ECB monetary policy decisions. Thus, we reject hypothesis 1. One day before
the announcement date, we observe negative abnormal returns for Finland from a decrease
and positive abnormal returns for Belgium for the status quo. One day after the
announcement date, we observe negative returns for the German, Italian, and Spanish stock
market indexes from an unexpected decrease in the change in the ECB MRO. Moreover,
except for France, we do not ¯nd significant cumulative abnormal returns over the event
period (-1 day, +1 day). We observe abnormal returns for the Eurozone stock market
indexes (with the exceptions of Belgium and Finland) at the announcement date, which
mainly occur in response to the status quo and drive wealth destruction for shareholders
unless the status quo stands. At the announcement date, we also discover that we have an
unexpected increase in ECB monetary policy that are positive abnormal returns. These
results suggest that the incorporation of the ECB monetary policy announcement is quick.
They also are consistent with research into the speed of convergence toward efficiency
around macroeconomic news (Pearce and Roley, 1983; Ederington and Lee, 1995).
Accordingly, we focus hereafter on the announcement day for our analyses.
4.2 Stock Market Reaction to Unexpected ECB Monetary Policy According to
Business Conditions
From Figure 1, we observe that the moving correlation between the Euribor and the
DJEurostoxx50 index is not stationary over time. Over the study period, we observe three
cycles with positive moving correlations (from January 2000 to May 2001; from August 2001
to December 2003; and from September 2005 to March 2008). The rest of the analysis
period corresponds to negative correlations. Therefore, the decisions of the ECB do not
always have pro-cyclical effects on the Eurozone stock market. We split our analysis
according to three business conditions defined by McQueen and Roley (1993): low, medium,
and high.
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Table 7 : Abnormal Returns for the Eurozone Stock Markets
This table presents the cumulative abnormal returns for the BEL20 Index (Belgium), the DJEurostoxx50 Index
(Eurozone), the OMX Helsinki Index (Finland), the CAC40 Index (France), the Performance DAX30 Index
(Germany), the Milan MIB30 Index (Italy), the AEX Index (The Netherlands), and the IBEX35 Index (Spain). The
abnormal returns are estimated from the constant mean returns model. Event 0 corresponds to the
announcement date. Statistical significance is based on Boehmer et al. (1991) and is denoted (***),(**), and (*)
for 1%, 5%, and 10% respectively.
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Figure 1 : Moving Correlation Between DJEurostoxx50 and Euribor Correlation using a 360 days Rolling Window
In Table 8, we present the abnormal returns at the announcement date according to
business conditions. We observe different stock market reactions according these economic
states. Moreover, our results suggest that the stock market reacts more when the
unexpected change in the ECB MRO is downward. We find positive abnormal returns to
unexpected decreases in the ECB MRO for four domestic Eurozone stock markets in good
economic conditions. For example, in the German stock market, shareholders gained 1.82%.
An unexpected decrease in the ECB MRO thus corresponds to a good news for investors
when the economy is strong. A strong market's perception of the unexpected decrease in
the ECB MRO in good times is similar to that a median of economy. We find significant
abnormal returns of 2.35% for the aggregate Spanish stock market. Thus, we valid hypothesis
2.a. However, in contrast with the results for strong and median business conditions, we
observe large negative abnormal returns to unexpected decrease in the ECB MRO during
bad times, confirming hypothesis 2.b. This finding suggests that investors overreact to an
unexpected decrease in bad times, especially if the ECB decreases the MRO. For example,
we observe negative abnormal returns of 5.84% for the French stock market index.
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Table 8 : Abnormal Returns of Main Euro Stock Markets According Economic
States at the Announcement Date
This table presents the cumulative abnormal returns for the BEL20 Index (Belgium), the DJEurostoxx50 Index
(Eurozone), the OMX Helsinki Index (Finland), the CAC40 Index (France), the
Performance DAX30 Index (Germany), the Milan MIB30 Index (Italy), the AEX Index (The Netherlands), and
the IBEX35 Index (Spain) according to varying business conditions. The abnormal returns are estimated from
the constant mean returns model. The economic states as in McQueen and Roley (1993). Statistical significance
is based on Boehmer et al. (1991) and is denoted (***),(**), and (*) for 1%, 5%, and 10% respectively.
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Table 9 : Abnormal Returns for the Sectoral Eurozone Stock Indexes at the
Announcement Date
This table presents the cumulative abnormal returns for the noncyclical, cyclical, growth, and financial stock
groups. The de¯nition of the panels comes from a cluster analysis of Stoxx supersectors. The abnormal returns
are estimated from the constant mean returns model. Statistical significance is based on Boehmer et al. (1991)
and is denoted (***),(**), and (*) for 1%, 5%, and 10% respectively.
4.3 Stock Market Reaction to Unexpected ECB Monetary Policy According to
Industry
We finally turn to the question of which sectors are particularly affected by ECB monetary
policy. Based on the industry classification benchmark (ICB) published by Stoxx Ltd., we
carry out our event study among the European supersectors stock indices. ICB defined 10
industries divided in 19 supersectors. To make this classification more adequate to our
methodology, we identify these supersectors in four panels. Unfortunately, because of a lack
of data, the real estate supersector has to be removed of our sample. In Table 9 Panel A, we
aggregate the following supersectors: Oil & Gas, Chemicals, Basic Resources, Food &
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Beverage, Health Care, and Utilities. These supersectors, over the period of analysis,
appears less sensitive than the others to the business condition. That why we define this
panel \non cyclical". In contrary, Table 9 Panel B is called \cyclical" and it composed by
Construction and Materials, Personal & House Goods, Industrial Goods & Services, Retail,
and Travel & Leisure. Supersectors indexes aggregate in Table 9 Panel C, such as Media,
Technology, and Telecommunications, are indexes that their performance over the period
are fare better than the other indexes. We entitle this panel \growth". We also aggregate
the financial indexes in Table 9 Panel D. The effect of monetary policy on stock market
returns should differ across supersectors for several reasons such as the interest-sensitivity
of the demand, the exchange rate sensitivity for tradable goods industries and o® course the
financial structure of the firms in a supersector. Table 9 reports the results of our event
study on these four panels. First, we find important differences among the panels.
We thus find evidence on hypothesis 3. Second, Panel C reacts as expected. An unexpected
decrease of the MRO rate leads to a rise of the abnormal returns and vice versa. However,
few significant results are concentrated at the status quo event. Third, concerning Panel A, B,
and D, the results indicate that in most of supersectors indexes, financial investors react
badly when occurs a statu quo. Moreover, we observe positive abnormal returns at the
unexpected ECB MRO increase announcements.
5 Conclusion
In this paper, we analyze the Eurozone stock markets' reactions to unexpected ECB
monetary announcements. We construct an index including the ECB's decisions unexpected
by the ECB watchers. Unexpected announcements correspond to an event, and from these
events we carry out an event study in order to assess the abnormal returns of the Eurozone
stock markets.
Our methodology leads us to several results. First, we observe that the ECB's monetary
policy decisions are often predictable. The ECB's communication policy seems to be a
success. Second, we find unexpected changes in ECB monetary policy which affect both
aggregate and domestic Eurozone stock markets, mainly on the announcement date. Our
results suggest that Eurozone stock markets do not react at ECB surprises over the three-
day announcement period. Thus, the incorporation of changes in the ECB's MRO into
Eurozone stock prices is quick. Third, we ¯nd no evidence of an inverse relationship
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between the abnormal returns of Eurozone stock indexes and MRO around an unexpected
ECB monetary policy announcement. Fourth, we distinguish the stock market reaction
according to business conditions and industries. We observe that the impact of a surprise
monetary policy is negative in a bad business conditions and positive in a good times. Fifth,
the unanticipated changes in the ECB MRO rates announcements have abnormal effects only
for some sectorial stock indexes.
The monetary policy implications of our results are the following. Even if monetary policy
makers would like to impact Eurozone stock markets, they only could do it during good
conditions. However, there is always a lot of uncertainty to determine these periods.
Prudential rules are more likely to have an impact on asset prices. An interesting topic for
further research would be to expand our announcements sample to other information
released by the ECB, such as the ECB's monthly press conferences. Another one would be
to determine the informational content into stock prices of monetary policy news, especially
compare with the other economic news.
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