Equity markets are impacted more by the expectations of future monetary policy than the policy rate surprises on the day of the announcement of the policy by the RBI, according to an analysis.
According to a working paper prepared by RBI officials, the regulatory and development measures which are announced along with the monetary policy impact the stock markets.
“Equity markets are affected more by the changes in the expectations of future monetary policy (path factor) than the policy rate surprise (target factor) which is in agreement with the conventional thinking that equity markets are forward-looking,” the paper said.
The volatility in equity markets on the day of the policy announcement, it said, “is affected by both target and path factors, as markets digest the policy announcements and traders adjust their portfolios throughout the day”.
The paper is prepared by Mayank Gupta, Amit Pawar, Satyam Kumar, Abhinandan Borad and Subrat Kumar Seet from the Department of Economic and Policy Research.
The paper analyses the impact of monetary policy announcements on the returns and volatility in the Sensex by decomposing changes in overnight indexed swap (OIS) rates on policy announcement days into target and path factors.
The target factor captures the surprise component in central bank policy rate action, while the path factor captures the impact of the RBI’s communication on market expectations regarding the future path of monetary policy.
