Unconventional monetary policy and disaster risk: Evidence from the subprime and COVID-19 crises

doi:10.1016/j.jimonfin.2021.102543

. 2022 Apr:122:102543.

doi: 10.1016/j.jimonfin.2021.102543. Epub 2021 Nov 23.

Unconventional monetary policy and disaster risk: Evidence from the subprime and COVID-19 crises

Gustavo S Cortes¹, George P Gao², Felipe B G Silva³, Zhaogang Song⁴

Affiliations

¹ Warrington College of Business, University of Florida, 306 Stuzin Hall, PO Box 117168, Gainesville 32611-7168, FL, USA.
² Quantitative Equities, T. Rowe Price, 100 E. Pratt St., Baltimore 21202, MD, USA.
³ Trulaske College of Business, University of Missouri, 425 Cornell Hall, Columbia 65211, MO, USA.
⁴ Johns Hopkins University, Carey Business School, 100 International Drive, Baltimore 21202, MD, USA.

PMID: 34949899
PMCID: PMC8677330
DOI: 10.1016/j.jimonfin.2021.102543

Unconventional monetary policy and disaster risk: Evidence from the subprime and COVID-19 crises

Gustavo S Cortes et al. J Int Money Finance. 2022 Apr.

. 2022 Apr:122:102543.

doi: 10.1016/j.jimonfin.2021.102543. Epub 2021 Nov 23.

Authors

Gustavo S Cortes¹, George P Gao², Felipe B G Silva³, Zhaogang Song⁴

Affiliations

¹ Warrington College of Business, University of Florida, 306 Stuzin Hall, PO Box 117168, Gainesville 32611-7168, FL, USA.
² Quantitative Equities, T. Rowe Price, 100 E. Pratt St., Baltimore 21202, MD, USA.
³ Trulaske College of Business, University of Missouri, 425 Cornell Hall, Columbia 65211, MO, USA.
⁴ Johns Hopkins University, Carey Business School, 100 International Drive, Baltimore 21202, MD, USA.

PMID: 34949899
PMCID: PMC8677330
DOI: 10.1016/j.jimonfin.2021.102543

Abstract

We compare the interventions conducted by the Federal Reserve in response to the subprime and COVID-19 crises with respect to their effectiveness in reducing disaster risk. Using model-free measures of disaster risk derived from daily options data, we document that interventions in response to both crises reduced tail risks in domestic equity markets. The spillover effects of the two crises have been markedly dissimilar. While subprime interventions are generally characterized by negative spillovers to international equity markets, policy responses to the COVID-19 crisis are generally associated with positive spillovers. We interpret these results as consistent with the different degrees of protagonism by central banks in the two episodes, emphasizing the importance of a broader participation of monetary authorities in expanding their balance sheets to counteract the effects of major crises.

Keywords: COVID–19; Disaster risk; Monetary policy; Quantitative easing.

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Conflict of interest statement

The authors declare that they have no known competing financial interests or personal relationships that could have appeared to influence the work reported in this paper.

Figures

**Fig. 1**
Balance Sheet Expansion of Major Central Banks. This graph shows the expansion in the balance sheet of each major central bank from January 2008 to May 2021. The size of the balance sheet is measured by total assets, normalized to 100 in January 2008 to facilitate time-series comparisons around the main periods of interest (i.e., 2008 and 2020). The data are from each central bank’s website.

**Fig. 2**
Rare-Disaster and Swift-Recovery Measures around the COVID–19 Crisis for US Sector ETFs. This graph shows the time series of disaster risk (red areas below zero) and fast recovery expectations (blue areas above zero) for global equities from January 1, 2020 to June 30, 2021. The maturity for which tail risk is calculated in all panels is $τ = 1$ month. (For interpretation of the references to color in this figure legend, the reader is referred to the web version of this article.)

**Fig. 3**
Rare-Disaster and Swift-Recovery Measures around the COVID–19 Crisis for International Equity ETFs. This graph shows the time series of disaster risk (red areas below zero) and fast recovery expectations (blue areas above zero) for global equities from January 1, 2020 to June 30, 2021. The maturity for which tail risk is calculated in all panels is $τ = 1$ month. (For interpretation of the references to color in this figure legend, the reader is referred to the web version of this article.)

**Fig. 4**
Volatility of Rare-Disaster and Swift-Recovery Indices ( $Δ RIX$ ). This figure reports the serial evolution of the volatility of changes in rare-disaster (red) and swift-recovery (blue) expectations (standard deviation of daily $Δ {RIX}_{t, τ}^{(S, -)}$ and $Δ {RIX}_{t, τ}^{(S, +)}$ with $τ = 1$ month aggregated at the month level). The plots depicted correspond to the index volatility for (i) US equities (ticker SPX, upper-left plot), (ii) Japanese equities (ticker EWJ, upper-right plot), (iii) Eurozone equities (ticker FEZ, lower-left plot), and (iv) UK equities (ticker EWU, lower-right plot).

**Fig. 5**
Autocorrelation and Cross-Correlation Functions. This figure presents the auto-correlation and cross-correlation estimates for the time series of $Δ {RIX}_{t, τ}^{(S, -)}$ with $τ = 1$ month for (i) US equities (ticker SPX), (ii) Japanese equities (ticker EWJ), (iii) Eurozone equities (ticker FEZ), and (iv) UK equities (ticker EWU). The sample period considered in the estimation is from April 14, 2008 to June 30, 2021 (period with valid observations for the four series).

**Fig. 6**
Extreme Tail Risk Term Structure and Unconventional Monetary Policy Surrounding the Subprime Crisis: US Domestic Effects. Each plot represents our estimates of abnormal changes in the term structure of extreme-left (red) and extreme-right (blue) tail risk (coefficients $β_{1}^{(τ)}$ ) obtained from Eq. (5) for different underlying ETFs and different horizons ( $τ$ ). 95% confidence intervals are estimated with Newey–West HAC robust standard errors.

**Fig. 7**
Disaster Risk Term Structure and Unconventional Monetary Policy Surrounding the Subprime Crisis: Spillover Effects. This Figure shows the abnormal co-movements (coefficients $β_{3}^{(τ)}$ of Eq. (6)) estimated for the relevant dates of policy announcements in response to the subprime crisis. 95% confidence intervals are computed with HAC robust Newey–West standard errors for the time-series estimates and with standard errors double-clustered at the geography and day levels for panel estimates (pooled sample of countries in the lower panel).

**Fig. 8**
Extreme Tail Risk Term Structure and Unconventional Monetary Policy Surrounding the COVID–19 Crisis: US Domestic Effects. Each plot represents our estimates of abnormal changes in the term structure of extreme-left (red) and extreme-right (blue) tail risk (coefficients $β_{1}^{(τ)}$ ) obtained from Eq. (5) for different underlying ETFs and different horizons ( $τ$ ). 95% confidence intervals are estimated with Newey–West HAC robust standard errors.

**Fig. 9**
Disaster Risk Term Structure and Unconventional Monetary Policy Surrounding the COVID–19Crisis: Spillover Effects. This Figure shows the abnormal co-movements (coefficients $β_{3}^{(τ)}$ of Eq. (6)) estimated for the relevant dates of policy announcements in response to the COVID–19 crisis. 95% confidence intervals are computed with HAC robust Newey–West standard errors for the time-series estimates and with standard errors double-clustered at the geography and day levels for panel estimates (pooled sample of countries in the lower panel).

**Fig. 10**
Disaster Risk Term Structure and Unconventional Monetary Policy Surrounding the COVID–19 Crisis: Interaction of Spillover Effects with the “Trilemma” Components. This Figure shows the triple interaction coefficients of abnormal co-movements estimated for the Fed’s announcement dates to the COVID–19 crisis with (i) monetary independence (Panel A); (ii) exchange rate stability (Panel B); and (iii) financial openness (Panel C). Panel D represents the estimates of the interaction effects with monetary independence excluding Eurozone countries. 95% confidence intervals with standard errors double-clustered at the geography and day levels.

**Fig. 11**
Disaster Risk Term Structure and Unconventional Monetary Policy Surrounding the COVID–19 Crisis: Interaction of Spillover Effects with Fiscal Space Indicators. This Figure shows the interaction effects of the abnormal co-movements estimated for the relevant dates of policy announcements in response to the COVID–19 crisis with different indicators of government debt sustainability, including (i) general government gross debt, % of GDP ( ${ggdy}_{c}$ ); (ii) primary balance, % of GDP ( ${pby}_{c}$ ); (iii) cyclically-adjusted balance, % of potential GDP ( ${cby}_{c}$ ); (iv) fiscal balance, % of GDP ( ${fby}_{c}$ ); (v) general government gross debt, % of average tax revenues ( ${dfggd}_{c}$ ); and (vi) fiscal balance, % of average tax revenues ( ${dffb}_{c}$ ). 95% confidence intervals are computed with standard errors double-clustered at the geography and day levels.

**Fig. B.1**
Rare-Disaster and Swift-Recovery Measures around the Subprime Crisis for US Sector ETFs. This graph shows the time series of disaster risk (red areas below zero) and fast recovery expectations (blue areas above zero) for global equities from January 1, 2020 to December 31, 2010. The maturity for which tail risk is calculated in all panels is $τ = 1$ month. (For interpretation of the references to color in this figure legend, the reader is referred to the web version of this article.)

**Fig. B.2**
Rare-Disaster and Swift-Recovery Measures around the Subprime Crisis for International Equity ETFs. This graph shows the time series of disaster risk (red areas below zero) and fast recovery expectations (blue areas above zero) for global equities from January 1, 2008 to December 31, 2010. The maturity for which tail risk is calculated in all panels is $τ = 1$ month. (For interpretation of the references to color in this figure legend, the reader is referred to the web version of this article.)

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[1] Aizenman J. International Coordination and Precautionary Policies. Int. Econ. J. 2016;30:379–391. doi: 10.1080/10168737.2016.1211839. - DOI

[2] Aizenman J. International Coordination and Precautionary Policies. Int. Econ. J. 2016;30:379–391. doi: 10.1080/10168737.2016.1211839. - DOI

[3] Aizenman J., Chinn M.D., Ito H. The Emerging Global Financial Architecture: Tracing and Evaluating New Patterns of the Trilemma Configuration. J. Int. Money Financ. 2010;29:615–641. doi: 10.1016/j.jimonfin.2010.01.005. - DOI

[4] Aizenman J., Chinn M.D., Ito H. The Emerging Global Financial Architecture: Tracing and Evaluating New Patterns of the Trilemma Configuration. J. Int. Money Financ. 2010;29:615–641. doi: 10.1016/j.jimonfin.2010.01.005. - DOI

[5] Aizenman J., Chinn M.D., Ito H. The ”impossible trinity” hypothesis in an era of global imbalances: Measurement and testing. Rev. Int. Econ. 2013;21:447–458. doi: 10.1111/roie.12047. - DOI

[6] Aizenman J., Chinn M.D., Ito H. The ”impossible trinity” hypothesis in an era of global imbalances: Measurement and testing. Rev. Int. Econ. 2013;21:447–458. doi: 10.1111/roie.12047. - DOI

[7] Aizenman J., Chinn M.D., Ito H. Monetary Policy Spillovers and the Trilemma in the New Normal: Periphery Country Sensitivity to Core Country Conditions. J. Int. Money Financ. 2016;68:298–330. doi: 10.1016/j.jimonfin.2016.02.008. - DOI

[8] Aizenman J., Chinn M.D., Ito H. Monetary Policy Spillovers and the Trilemma in the New Normal: Periphery Country Sensitivity to Core Country Conditions. J. Int. Money Financ. 2016;68:298–330. doi: 10.1016/j.jimonfin.2016.02.008. - DOI

[9] Aizenman J., Chinn M.D., Ito H. Balance Sheet Effects on Monetary and Financial Spillovers: The East Asian Crisis Plus 20. J. Int. Money Financ. 2017;74:258–282. doi: 10.1016/j.jimonfin.2017.02.020. - DOI

[10] Aizenman J., Chinn M.D., Ito H. Balance Sheet Effects on Monetary and Financial Spillovers: The East Asian Crisis Plus 20. J. Int. Money Financ. 2017;74:258–282. doi: 10.1016/j.jimonfin.2017.02.020. - DOI

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Unconventional monetary policy and disaster risk: Evidence from the subprime and COVID-19 crises

Affiliations

Unconventional monetary policy and disaster risk: Evidence from the subprime and COVID-19 crises

Authors

Affiliations

Abstract

Conflict of interest statement

Figures

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References

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