Post-Brexit Stock Market Volatility and European Central Bank Reaction Function

Nahid Kalbasi Anaraki^1,

¹Fort Hays State University, Economics Department

Cite this paper:
Nahid Kalbasi Anaraki. Post-Brexit Stock Market Volatility and European Central Bank Reaction Function. Journal of Finance and Economics. 2018; 6(6):237-241. doi: 10.12691/jfe-6-6-5

Abstract

The European stock markets experienced enormous volatility in stock markets post-Brexit era, which wasn’t observed before the shock. The volatility in financial markets has disturbed economic fundamentals including capital flow and economic growth in several European countries. To avoid such disturbances the monetary authorities have to implement a monetary reaction function by adopting an appropriate range for short-term interest rate consistent with the volatility of stock markets and depreciation of British pound. The monetary reaction function in this case shouldn’t be only based on traditional Taylor’s rule but also needs to take into account the volatility of stock markets and depreciation of pound versus major currencies. The goal of this paper is twofold. First, it tries to estimate the effects of Brexit on stock market volatility index for British FTSE, German DAX, and French CAC using econometric models and a dummy variable for post-Brexit. Second, it uses a Vector Auto Regression (VAR) model to stimulate the monetary reaction function of the European Central Bank (ECB) to find out how it may neutralize the adverse effects of stock market volatility on macroeconomic fundamentals.

Keywords:
Brexit stock market volatility Vector Auto Regression model (VAR) monetary policy reaction function Taylor rule currency depreciation European Central Bank

This work is licensed under a Creative Commons Attribution 4.0 International License. To view a copy of this license, visit http://creativecommons.org/licenses/by/4.0/

References:

[1]	Raddant, M. (2016). The Response of European Stock Markets to the Brexit, Kiel Policy Brief, Kiel Institute for the World Economy, No. 100.
[2]	Busch, B., & Matthes, J. (2016). Brexit, the Economic Impact, A Meta Analysis, Cologne Institute for Economic Research, IW Report 10/2016.
[3]	Belke A., Dubova, I., & Osowski T. (2016). Policy Uncertainty and International Financial Markets: The Case of Brexit, CEPS Working Document, No. 429.
[4]	Breinlich, H., Leromain, E., Novy, D., Sampson, T., Usman, A. (2018). The Economic Effects of Brexit-Evidence from Stock Market, University of Surrey, London School of Economics, University of Warwick, and University of Nottingham.
[5]	Raddant, M., & Wagner, F. (2014). Transitions in the Stock Markets of the US, UK, and Germany, Kiel Institute for the World Economy, Working Paper No. 1979.
[6]	Corradi, V., Distaso, W., & Mele, A. (2008). Macroeconomic Determinants of Stock Market Returns, Volatility and Volatility Risk-Premia, University of Warwick, Discussion Paper No. 616.
[7]	Hsing, Y. (2011). Macroeconomic Determinants of the Stock Market Index and Policy Implication: The case of a Central European country, Eurasian Journal of Business and Economics, Vol 4, 7, pp. 1-11.
[8]	Barasa, J. (2014). Macroeconomic Determinants of Stock Market” Performance in Kenya: Case of NAIRUBI Securities Exchanges, University of Nairobi.
[9]	Gregor, I (2015). Brexit: The impact on the UK and the EU, Global Counsel, UK.
[10]	Springford, J., Tilford, S., McCann, P., Whyte, P., & Odendahl, C. (2016). The Economic Consequences of Leaving the EU, the Final Report of the Center for European Reform (CER) Commission on Brexit 2016, London.
[11]	Begg, I., and Mushovel, F. (2016). The Economic Impact of Brexit: Jobs, Growth and Public Finances, European Institute and London School of Economics.
[12]	Goodwin, A. (2016).The short-term impact of Brexit, United Kingdom Economic Outlook, Volume 40(2), pp1-86.
[13]	Jackson, J. (2016). Economic Implications of a United Kingdom Exit from the European Union, Journal of Review of Banking and Finance Law, Vol. 36.
[14]	Jackson, J., Akhtar, S., & Mix, D. (2016). Economic Implications of a United Kingdom Exit from the European Union, Congressional Research Service, 7-5700, CRS Report.
[15]	Kierzenkowski, R., Pain, N., Rusticelli, E., Zwart, S. (2016). The Economic Consequences of Brexit: A Taxing Decision, OECD Economic Policy Paper. No 16.
[16]	Felbermayer, G., Fuest, C, Groschl, J., and Stohlker, D. (2017). Economic Effects of Brexit on the European Economy, EconPol Policy Report, No. 4, Vol 1.
[17]	Bohdalova, M. & Gregus, M. (2017). The Impacts of Brexit on European Equity Markets, Comenius University, Slovakia.
[18]	Frankel, J. (1993). Monetary and Portfolio Balance Models of Exchange Rate Determination, MIT Press, Cambridge.
[19]	Hacker, S., Kim, H. & Mansson K. (2009). The Relationship between Exchange Rates and Interest Rate Differentials: A Wavelet Approach, Jonkoping International Business School, Center of Excellence for Science and Innovation Studies, Sweden.
[20]	Gerlach-Kristen, P. (2003). Interest Rate Reaction Function and the Taylor Rule in Euro Area, European Central Bank, Working Paper No. 258.
[21]	Taylor, J. B., and Volker, W. (2016). Finding the Equilibrium Real Interest Rate in a Fog of Policy Deviation, Stanford University.