What Did Krish and Viss Say at Jackson Hole?

The financial press reacted with astonishment and disbelief to Krishnamurthy and Vissing-Jorgensen’s paper (Krish and Viss) at the recent Federal Reserve conference at Jackson Hole. The two authors simply analysed the “announcement effect” on Treasury, corporate and mortgage bond yields around the announcement date for QE1 and QE2. Exactly why the financial press is so confused by the paper is curious. The paper is written in standard academic finance language, so this may contribute to the misunderstanding since the popular press is more accustomed to low-level economic commentary.

Krish and Viss employed a very old technique called an “event study” to look at before and after price effects surrounding important announcements. It is a carried assumption in event studies that most of the price impact of an announcement will be impounded in asset prices within minutes, beyond which there is unlikely to be any ongoing additional impact. QE1 and QE2 displayed exactly this behaviour. The authors discovered significant announcement effects which lasted for several minutes and in some cases several hours, however little else in terms of long-term systematic price affects. Economists and journalists don’t like these findings since they essentially invalidate the importance of their own ongoing analysis and commentary.

QE1 was found to contain the most sizeable impact on prices, largely because it was announced in the midst of the 2008 to 2009 crisis months. QE2, alternatively, displayed a more muted impact. One interpretation of the paper is that the QE policies generally have had much less impact on the financial markets than the popular press has promoted.

This is a triumph for finance over economics. Krish and Viss are no doubt perplexed by all the fuss. After all, it is well known in finance that markets react quickly and quite efficiently to new information. The lack of persistence in the ongoing policy impact on prices should be no surprise to anybody. The corollary is that once the Fed announces its exit from the same policy, then prices will quickly and effectively impound this information. This has already taken place in May this year, which is when the Fed foreshadowed its tapering at some point in the future. Much to the disbelief in the financial press, there is unlikely to be any impact on prices when the Fed finally reduces its involvement in the markets.