Title: Bremia: A study of the impact of Brexit and COVID-19 based on bond prices
Authors: Jagjit Chadha - NIESR (United Kingdom)
Arno Hantzsche - HMT (United Kingdom)
Cyrille Lenoel - NIESR (United Kingdom)
Corrado Macchiarelli - National Institute of Economic and Social Research (United Kingdom) [presenting]
Sathya Mellina - Enel Group (Italy)
Abstract: Many financial prices reacted violently to the result of the UK's advisory referendum held on 23 June 2016 and to the spread of COVID-19. Subsequently, financial prices have proved significantly less volatile, both unconditionally and in response to the news. We want to understand what sovereign bond prices might have been telling us about the likely state of the British economy under an exit from the European Union and its re-orientation in light of COVID-19. To do so, we model the factors determining the term structure of interest rates and find that bond yields are driven by macroeconomic factors, as well as by central bank communication which we quantify using text mining techniques. When we map our results to movements in response to the news, we find that bond yields decline in anticipation of more expansionary monetary policy. A plausible explanation is that bond markets have started to anticipate further QE. In this sense, the change in expectations about monetary policy appears to have offset any Brexit-related rise in any primitive risk premium. Instead, our preliminary results for COVID-19 are rather mixed, arguably because of a lack of data-points, and we treat them as very tentative. We find that COVID-19 uncertainty did not significantly increase term premia at the 10-year maturity in the same manner as Brexit-related uncertainty. This seems to be consistent with the view that market participants expect a hefty but not enduring crisis.