Risk, uncertainty and monetary policy

• We decompose the VIX index into a “risk aversion” and an “uncertainty” component.
• We study how monetary policy affects the VIX components in a structural VAR framework.
• A lax monetary policy decreases both risk aversion and uncertainty.
• Monetary policy effects are also apparent in regressions using high frequency data.

The VIX, the stock market option-based implied volatility, strongly co-moves with measures of the monetary policy stance. When decomposing the VIX into two components, a proxy for risk aversion and expected stock market volatility (“uncertainty”), we find that a lax monetary policy decreases both risk aversion and uncertainty, with the former effect being stronger. The result holds in a structural vector autoregressive framework, controlling for business cycle movements and using a variety of identification schemes for the vector autoregression in general and monetary policy shocks in particular. The effect of monetary policy on risk aversion is also apparent in regressions using high frequency data.