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Interest Rates v. Market Volatility

Hi everyone,
My name is Preston Yadegar and I’m a student at Boston University working in the quant research team within the BU Finance and Investment Club. I created a notebook to test my hypothesis that when interest rates increased, market returns were more volatile. I uploaded interest rate (effective fed funds rate) data from FRED while using SPY to measure the broad market (or at least large cap firms). I also use a Levene Test to compare the variances of the two groups, because I found the data to be non-normal (so the results of an F-Test were inappropriate). In the notebook I have some links on the Levene Test and some other topics I referenced along the way. I would greatly appreciate any criticism or comments about my notebook. Thanks!
P.S. if you want to run the notebook, upload the FRED data to your ‘Data’ folder in the Research environment and name it ‘DFF.csv'

Also if you're curious to see what other hypothesis testing we're doing, check out these other posts:

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7 responses

Hey there,

Great post, I like the clear hypothesis. This is an interesting result. It seems you've established some evidence towards a relationship, and the next step would be to unpack what is actually happening here. Why does the variance increase? How fast does it increase? How long does it take for the information about interest rates to be absorbed into the market. These are all key elements of the system you'd have to understand to be able to predict outcomes.


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Hi Delaney,

I'll look into those questions and do more testing on the strength of variance increase and such. Also that last one about checking for a delay/lag time could be interesting as well. Thanks for the ideas and comments!

Nice work!

One idea is to test the relationship between the direction of interest rates and the implied volatility of S&P 500. One measure is the VIX index. Does the change in the funds rate influence either the movement in the vix index, or the accuracy of the prediction the vix index is making (the future realised volatility).

Hey Dan,

That would be interesting to compare these overnight interest rates to the VIX. I actually trade VIX futures and options and this sounds very cool. I'll try and get another notebook on the relationship between the VIX and fed funds. Could also be cool to look at 1-month interest rates which match the VIX as a 30-day average. Thanks for the idea Dan!

By the time the US Fed announces an interest rate hike, a market consensus would already have been built into which way the interest rates are going. That consensus should reflect in the long term bond yield curve. The actual announcement would probably cause a small spike in volatility but not cause big moves in the market over the long term.


Hey Kamal,

Thanks for the comment, I hadn't thought about markets pricing in the consensus over time. Rather than short term fed funds (which the Fed usually has vast control over), do you think it would be valuable to measure medium/long term rates against broad volatility? I'm thinking that since the Fed has less influence on long term rates, those rates may react independently from Fed actions and have a relationship to volatility.


Hi Preston,

If you look at long term bond rates, they move v little in relation to short term interest rate spikes. That is because they need to take into account all possible interest rate movements within the maturity date (which spans several economic cycles) and also indicate sovereign rating of the country.
You may also want to cross-check if there are hedge funds that adopted your strategy and beat the market in any way.