Does the Fed Put Really Exist?

The Fed, or Greenspan, put is a monetary policy tool used by the Federal Reserve to help stabilize the economy. The name comes from former Federal Reserve Chairman Alan Greenspan, who is credited with using the tool to help stave off a recession in the early 2000s.

The Fed put works by the Federal Reserve buying up Treasury bonds and other assets in order to inject money into the economy. This extra cash flow can help to boost economic activity and prevent a downturn.

Reference [1] formally examined the existence and impact of the Fed put.  It used option prices to test if monetary policy has a significant impact on stock market participants’ expectations. Using three different methodologies, namely the Taylor Rule, Natural Language Processing (NLP) applied to FOMC minutes, and Hidden Markov Models (HMM), the authors confirmed the existence of the Fed put,

We find evidence that markets adjust the prices of traded options to take into account the Fed Put. We also find that the impact of the Fed Put on traded options was significantly larger in period before the 2008 financial crisis. Our results suggest that the Fed policy had an impact on option prices that cannot be explained purely due to its impact on the real economy.

The paper also pointed out that the impact of the Fed put has declined after the Financial Crisis,

In contrast, we find that the Fed Put has declined after the Financial Crisis. This is also the period with Quantitative Easing. Our results suggest, but do not prove, that the Financial Crisis has substantially reduced market’s expectations of protection against downside risk. We are not able to deduce whether this decline is because of historically low discount rates or because the market’s expectations have been permanently altered, such as the so-called Yellen call.

References

[1]  Dahiya, Sandeep and Kamrad, Bardia and Potì, Valerio and Siddique, Akhtar R., Fed Put in the Equity Options Markets, 2022, https://ssrn.com/abstract=4184702

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