The impact of federal funds target changes on interest rate volatility

This paper empirically investigates the 1-day response of interest rate volatility to a federal funds target rate change over the period 1989-2003. Federal funds futures data are used to distinguish between anticipated and unanticipated changes in the funds rate target. Interest rate volatility is modeled as an EGARCH process. The volatility response to an unanticipated Fed policy action is relatively large in size and highly significant for short-term interest rates. However, interest rates at long maturities are found to be responsive to target rate changes, even if they are anticipated, when estimations take into account of structural change in association with the Fed's policy disclosure beginning in 1994, as well as asymmetrical effects between monetary easing and tightening.