RBI And Equity Market (Image Source: iStockphoto)
A recent analysis conducted by officials at the Reserve Bank of India (RBI) suggests that equity markets are significantly influenced by expectations regarding future monetary policy, rather than immediate policy rate surprises announced by the central bank.
This conclusion, drawn from a working paper authored by Mayank Gupta, Amit Pawar, Satyam Kumar, Abhinandan Borad, and Subrat Kumar Seet from the RBI’s Department of Economic and Policy Research, underscores the forward-looking nature of equity markets.
Target vs. Path Factors: Understanding Market Dynamics
The study highlights two key factors influencing equity market behavior: the “target factor” and the “path factor.” While the target factor encompasses the surprise element in central bank policy rate actions, the path factor captures the impact of the central bank’s communication on market expectations regarding the future trajectory of monetary policy.
Volatility Dynamics: Market Reaction on Policy Announcement Days
According to the paper, the volatility observed in equity markets on the day of policy announcements is influenced by both target and path factors. This volatility reflects the market’s reaction as it absorbs policy announcements and traders adjust their portfolios in response.
Analyzing Policy Announcement Impact: Decomposing OIS Rates
The study analyzes the impact of monetary policy announcements on the returns and volatility of the BSE Sensex by decomposing changes in Overnight Indexed Swap (OIS) rates on policy announcement days into target and path factors. This approach provides insights into how market dynamics are shaped by central bank actions and communications.
Considerations and Limitations
The analysis acknowledges certain considerations and limitations. While short-duration windows aim to isolate the impact of monetary policy announcements on equity prices, regulatory and developmental measures announced alongside monetary policy can also influence market behavior. Additionally, factors such as sparse trading in OIS markets and other domestic and global developments during narrow windows may impact the analysis.
Scope and Duration of the Study
Covering the period from January 2014 to July 2022, the analysis spans the timeframe coinciding with India’s adoption of a flexible inflation targeting regime. This period offers a comprehensive view of the relationship between monetary policy announcements and equity market dynamics.
(With Inputs From PTI Agency)
