EFFICIENCY AND IMPACT OF ECB POLICY ANNOUNCEMENTS KERSTIN BERNOTH & JURGEN VON HAGENZ FOR EUROPEAN INTEGRATION STUDIES AND UNIVERSITY OF BONN, INDIANA UNIVERSITY, AND CEPR. THE PERFORMANCE OF THE EURIBOR FUTURES MARKET :

 Euribor is short for Euro Interbank Offered Rate.  Based on an average interest rates of inter-banking loans  Different maturities :15 Euribor rates (only 8 since November 2013)  The reference in the European money unsecured market  Provides basis for financial products:  Interest rate swaps / futures  Saving accounts  Mortgages  Corporate loans Introduction What is Euribor?

Introduction Euribor futures  A EURIBOR FUTURE is a futures contract with a Euribor deposit as the underlying asset.  The Three-Month Euribor Future is a commitment to engage in a three month loan or deposit of a face value of 1000,000 Euros.  4 delivery dates: Third Wednesday of March – June – September – December  Last trading day of each futures = 2 Tdays before the relevant settlement day  Futures prices are quoted on a daily basis  Interest rate equals 100 less the futures price.

A.The efficiency of three-month euribor interest rate future markets B. The Impact of the ECB’s monetary policy decision on the volatility of the Euribor future rates C. The impact of Governing Council meetings on the change in the absolute prediction error of the euribor futures rate Introduction What is the study about?

Data A. Testing money market efficiency  All data is provided by the London International Financial Futures and Options Exchange.  Sample: daily closing rates of the 19 Euribor futures contracts settled between March 1999 and September 2003 : t = 1,2,…, 19  All futures rates are a with forecast horizon of up to 6 months for each futures contract : t =1,2,…,183  Accounting for weekends: 131 cross-sections with 19 observations each.

 Equation of the time-series regression used:   Unbiasedness and efficiency requires :   The error term has to be uncorrelated  Because not enough contracts have been traded, test is not possible. Metholodgy A. Efficiency Market Hypothesis Spot Rate of a 3 month interbank deposit Risk Premium Futures rate at t-i of same deposit Colum Vector of variables Error Term

Methodology A. Efficiency Market Hypothesis  Use of a panel approach  Chow test does not reject the null hypothesis of poolability  Multiple futures rates with different maturity  Form N groups of futures rates with same forecast horizon (i )  We obtain a new equation:  Unbiasedness and efficiency requires :  The error term is uncorrelated 

Notes:1) F-Test accepted at a significance level of 10% 2) LM-Test accepted at a significance level of 10% 3) LM-Test rejected at a significance level of 5% Results A. Efficiency Market Hypothesis

 Future Rates (Forecast horizon < 4 months) :  EMH is Accepted, results are unbiased  Futures Rates (Forecast horizon > 4 months, level of confidence = 90%) :  EMH is Accepted, results are unbiased  Future rates (Forecast horizon > 4 months, level of confidence = 95%):  EMH is Rejected, but results are unbiased Markets are considered efficient only during the first years of EMU Interpretation A. Efficiency Market Hypothesis

Data B. & C. The impact of monetary policy announcements  The ECB Governing Council. : 1st and 3rd Thursday of a month  During the sample period:  92 meetings occurred  16 where interest rates were changed  6 of them took place on Wednesdays  1 on a Monday  November 2001 change of policy: assess its monetary policy stance only in the first meeting of the month.

Data B. & C. The impact of monetary policy announcements

Effects of ECB’s announcements B. Volatility  Volatility is used as a measure for quality of ECB’s information  Volatility = Absolute change in the futures rate between two trading days x100 =  Because EMH → Reaction of futures rates if concerned by announcements in monetary policy decisions

Effects of ECB’s announcements B. Volatility  Regress the volatility & check on week-day effects  Use of a panel estimator as well Note: P values are reported in squared brackets. Volatilities are multiplied by100 to express bps.  Wednesday ECB’s announcements → Thursday effect  Volatility is twice higher for 1st half of sample → Beginnings of the €

 4 days w/ volatility > 10BP  2 after ECB announcement  Low volatility after May 01  High volatility in Jan 01: Fed announcement  Market correctly follow ECB’s announcements → Uncertainty about timing Effects of ECB’s announcements B. Volatility

 3 dummies on 1st part  Red zone → Most volatile rates  After 2 years, drop to less than 1 → statistically insignificant Effects of ECB’s announcements B. Volatility

Effects of ECB’s announcements C. Changes of the absolute prediction error on governing council-days and non-council days

 6 outliers → changes > ten basis points in absolute values  4 → large improvement in prediction  3 on Council days  Positive & negative changes have same frequencies  Softening of the prediction error change curve Improvement of the market’s prediction ability of future spot rates Effects of ECB’s announcements C. Prediction error

 Euribor futures rates with a forecast horizon of up to 4 months are informationally unbiased and belong to an efficient market  Euribor futures rates with a forecast horizon of more than 4 months are informationnally unbiased but are not considered as efficient market Conclusion A. The efficiency of 3-M Euribor interest rate future market

 First 5 years of EMU : VOLATILITY of the Euribor futures rates on GC days is significantly HIGHER than on non-council days  First 2 years of EMU: VOLATILITY of futures rates after policy actions is 3x HIGHER than the other days Conclusion B. The impact of ECB’s monetary policy on volatility of Euribor futures rates

 Information on Governing Council days did not systematically improve the markets’ ability to forecast interest rates  The predictability of ECB policy decisions have further improved during the first years of EMU. ECB Council decisions still cause some surprises, but their effect on volatility is small  ECB’s new information management in this environment has now been successfull Conclusion C. The impact of GC on the change in prediction error of Euribor futures rates