Why might event study not be an excellent way to study the input of the QEs?

Economists often use market reactions in the treasury yields shortly before the announcements of QEs, or other related events, to quantify the ‘impact’ of the asset purchases programs. But according to Greenlaw et al., this event study method might suffer selection bias, as economists only focus on the days with dramatic market movements.

Instead of focusing on some short time periods, they suggest a complementary observation technique: the authors are the Reuters News to double check the result of previous research results based on event studies. They record all the days that the 10-year US treasury yield had movement larger than one standard deviation, then the check the Reuters News report that day to identify the “source” of market movements. If the Reuters identified the Fed’s action or speech is the major reason for the market movement, it is marked as “Reuter Fed Day”. Then they added up all the market movement on “Reuters Fed Days” during the period of QE 1, QE 2, and QE 3, and use it to “measure” the impact of the Fed’s unconventional monetary policies.

Here is the summary of all the 10-year treasury yield reactions at the “Reuters Fed Days” (dark blue line).

The result shows that 10-year treasury yield is cumulatively lower in all ‘Reuters Fed Days’ during the period, as one would expect from a monetary easing policy.

However, most of the fall in yield concentrated in the period before QE 1; During QE 2 and QE 3, the cumulative fall in l0-year yield actually got smaller, which means that the yield is trending higher even with all the Fed actions. This put in doubt the effectiveness of the event study method, as economists will miss out all the subsequent market movements that might be related to the QE. In this particular case, the “effect” of QEs might have faded away very soon after it is implemented.

The research also distinguished the reason for yield changes on “Reuters Fed Days’” between “balance sheet news-related” and “interest rate news-related”.

One the one hand, the yield change related to interest rate remains negative and stable during the period; one the other hand, the cumulative yield change on days dominated by news about the Fed’s balance sheet fell before QE1, but the yield is trending upward since then and turned positive before QE3. Again, this is not a picture one should expect as QE should lower the 10-year yield instead. This is why the authors make a bold claim that that interest rate policy is a better way to ease monetary policy, as compared to asset purchase programs as the effect is well known and stable.