The Impact of U.S. Quantitative Easing (QE) Announcements on Indian Government Bond Yields

Abstract

This study investigates the impact of U.S. Quantitative Easing (QE) announcements on Indian Treasury yields. Two outstanding channels of spillover effects on bond yields documented in the existing literature are signalingchannel and portfolio balance channel. This study decomposes Indian Treasury yields into yield expectationsand risk premia to measure spillover effects of U.S. QE announcements. The impact on yield expectationmeasures signaling effect while the impact on risk premia measures portfolio balance effect. It is observed that FOMC announcements of Federal Reserve’s Quantitative Easing (QE) policy treated as shocks to Indian government bond yields. To investigate the announcement effects on Indian government Bond yields, event study methodology is used to capture the change in the bond yields, yield expectation and risk premia of Indian bond market around that time especially during the first round of Quantitative Easing (QE1) policy announcement periods in one-day and two-day window period. To support event study results regression analysis method is implemented and found robust evidence supporting larger signaling effect than the portfolio balance effect. At last, this study uses Dynamic Nelson-Siegel (DNS) yield curve model to compute the relationship between the U.S. and Indian Bond market. DNS model involves two-step estimation using VAR regression on Indian government bond yields with U.S. 10-year Treasury yield changes as an exogenous variable. The statistical result of DNS estimation shows that U.S. 10-year Treasury yield change affects the Indian long-term bond yield during the financial crisis period.