The Impact of ECB’s Unconventional Monetary Policy on the German Stock Market Volatility

Abstract This study investigated the reaction of German stock market volatility (Dax index) to the European Central Bank (ECB)’s unconventional monetary policy (UMP) announcements. The financial crisis of 2008 proved that the traditional monetary policy’s tool (the short -term interest rate) has lost its effectiveness to meet the new challenges. So, the key central banks, ECB included, had to implement the new, untested and nonstandard monetary policy which so called unconventional monetary policy. In this study, we used the ECB’s shadow policy rate approach to extract unconventional monetary policy. Also, We employed GJR GARCH (p,o,q) model to estimate the volatility in the German stock market. Then we calibrated both OLS (linear regression) and Markov-switching (probability-matrix of regime changes) models to examine the reaction of German stock returns volatility to UMP announcement by ECB for a period from January 2006 to December 2019. The results delivered by both models showed that the ECB’s UMP had a strong and negative effect on the volatility of the German stock market. Also, both models showed that the past German stock volatility has a significant and negative effect on the dependent variable, while the volatility of the German stock returns is a function of the global volatility estimated by the VIX index. Moreover, the results showed that the Markov-switching regression model provides a better illustration of the stock market volatility impact of UMP than the OLS model because it can represent the changes into the two different regimes named ordinary regime and quantitative easing (crisis) regime. Furthermore, under the Markov-switching regression model, we can see how the output gap and the inflation gap influence the volatility of the Dax index, while the results of the OLS regression model showed that there is no significant relationship between the output gap and the inflation gap with the German stock market volatility.