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Caravel Undergraduate Research Journal

Abstract

What is the most effective government policy to boost stock returns and, subsequently, to foster economic growth, especially during an economic crisis? This paper examines the effects of various government actions on stock market performance during the global financial crisis of 2007. As expected from rational investors, nearly all of the variation in index levels is explained by the variation in index futures levels, which reflect market expectations. Index and future levels were collected for June 2007-December 2009 using Bloomberg, which tracks data for various financial instruments. The financial crisis timeline furnished by the New York Federal Reserve Board on its website was used to determine important policies, which were then categorized into eight groups. Dummy variables were created for each of these categories corresponding to the date on which the event in question occurred. VIX futures are used to model market expectations of volatility; federal funds futures, of the federal funds rate. Regressions using the ordinary least squares measure and correcting for autocorrelation were performed with market expectations of index levels as the dependent variable. Significant predictors of index futures were volatility futures, federal funds rate futures, and the creation or adjustment of swaps. The most effective way to change stock market returns is to change expectations, and the most practical way to change expectations is to decrease the federal funds rate.

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