THE EFFECT OF MONETARY POLICY ON YIELD CURVES OF GOVERNMENT COUPON BONDS (EXAMPLE OF ARMENIA)
To make the path of the transition mechanism of monetary policy smooth it’s important to realize the reaction of the government bond yield changes to any event. Besides many individual and institutional investors need this for their investment decisions. Although there are many theories which try to explain the behavior of short and long term rates, but we have found them irrelevant to spread to the Armenian case. This research aims to estimate the reactions of the yields of Armenian government coupon bonds to discount rate changes (one of the monetary policy tools) amid predetermined endogenous and exogenous factors. There are three scenarios which describe the behavior of bond yields which depends on whether Central bank does have secret information not available to public or it changes its priorities. The first is that when Central bank does have secret information. In this case public figures out the shocks hitting economy by investigating the monetary policy done by the Central bank. The second is when Central bank doesn’t have secret information. In this case market participants will react appropriately to monetary policy. And the last case is when Central bank implements monetary policy not because of inflation or other macroeconomic target but because of changing priorities. However we have not followed these scenarios. We have taken two scenarios which are distinguished by exogenous and endogenous factors. Yield curves are affected by many factors which change the levels and shapes of yield curves. Among these factors are social, legal, economic and political situations. However taking into account that yield curves are mostly affected by monetary policy this research is devoted to discovering discount rate changes’ effects on bond yield curves. Discount rate is one of the tools used by the Central bank of Armenia for implementing monetary policy. Short and long term repo transactions are the main operations done by the Central bank. Changing discount rates affects repo transactions’ volume which in turn may change shapes and levels of government bond yieldcurves. 172 Դրամավարկային քաղաքականության ազդեցությունը պետական պարտատոմսերի… So we have used different mathematical tools for analyzing bond yields behaviors. Firstly Bayesian VAR was used to evaluate the relationship between discount rate and government bond yields. Impulse response function was derived which showed that response of yields of different maturities to discount rate is low during the near days, but after that it rises that’s yields response slowly to monetary policy. For long term rates impulse response function is initially negative but then becomes positive and rises in value. Besides that impulse response function for long term rate is many times lower than for short term rates. After that variance decomposition has been done to find what percentage of variance of yields forecasts are explained by discount rate. The results emphasized that discount rate does have very little impact on variance, but again like impulse response rises with number of days after discount rate changes. As results show both impulse response and variance decomposition rise with maturities of yields till six month where they reach their maximum values. After that their values decline with maturities. So we can conclude that six month rate takes the highest effect during discount rate change. As a way for dividing monetary days as endogenous and exogenous we have taken the days when the direction of discount rate change and inflation change coincides (for endogenous). Although this is very simple way of analyzing inflation impact on bond yields changes, results are very essential. To discover what kind of impact does discount rate have on yields dummy variable has been inputted into the regression which divides inflation-related monetary policy days and non-inflation-related days which is the same as endogenous and exogenous effects. Although these method is not the most efficient because expected inflation also can affect the discount rate decision but this is the only way for our analysis and beside that we don’t have data on expected inflation. Results of regression analysis imply that when discount rate is raised or lowered by Central bank for affecting inflation, their impact on short term rates is lower than for long term rates. That’s when other factors but inflation affect the Central bank to change discount rate short term yields will be affected more that long term rates. This is very auspicious result and coincides with other results found in literature. So in this case yield curve rotates around some special point which was also discovered by other researchers. Although there are meetings of board of the Central bank of Armenia when discount rate doesn’t change. Initially it seems that this doesn’t affect the market however market participants forecast future operations of Central bank and thus affect bond market in the current time. We have chosen all these days when the Central bank of Armenia has not changed discount rate. Because of the fact that we don’t have enough data we’ve combined all maturity yields and computed arithmetic averages of all maturities. After that we have run regression on CPI for respective days. What we’ve found is that inflation changes affect bond yield curves, and the results are significant. So during monetary days when discount rate doesn’t change inflation affects short and long term rates. The main reason is that inflation is taken as expected inflation by the market and market participants adjust yields to incorporate inflation changes. But which maturities react more or less is out of the scope of this article. After that we have tried to find out how each maturity yield changes after discount rate is raised or lowered. For that we have approximated times series of every yield by Fourier series which uses combination of sines and cosines. For yields we’ve used eight sines and eight cosines to approximate yield series. The functions which we’ve found for every maturity yield series are used as a way for discovering yields’ behavior. We have calculated the derivatives of Fourier series on the tenth day after discount rate changes. We used tenth day because we’ve seen that effect of discount rate change doesn’t seem visible during the near days. So the longer those days the better the results. After that derivatives as slopes were divided according to endogenous and exogenous factors defined above. What we’ve found is that in case of contractionary monetary policy exogenous factors affect yields in a way that short term rates change much faster than long term rates. In case of expansionary monetary policy the patterns are a little bit opaque, but we can say that exogenous factors affect in a way that yields of short and long terms change much faster. Here we must not confuse the values of impulse response function and the values of slopes. The former shoes the sensitivity to discount rates and the latter shows the sensitivity to time. We can assert that the effect of discount rate changes on yield curve is not conspicuous. Discount rate change starts to affect yield curves very slowly but as time passes the effects can be seen. We need more than thirty days to see some changes in yield curves. The reason of this is that Armenian bond market is not liquid and that’s why market reacts slowly. Also one point we need to emphasize is that yield curve behavior to discount rate change is different for different maturities and under different circumstances. This fact can be used to enhance the effectiveness of monetary policy.