ISTANBUL TECHNICAL UNIVERSITY  GRADUATE SCHOOL OF ARTS AND

SOCIAL SCIENCES

THE IMPACTS OF POLICY INTEREST RATE CHANGES

ON FINANCIAL MARKETS IN TURKEY

M.Sc. THESIS

Neslişah BAŞAVCI

Department of Economics

Economics M.Sc. Programme

JULY 2020
ISTANBUL TECHNICAL UNIVERSITY  GRADUATE SCHOOL OF ARTS AND
SOCIAL SCIENCES

THE IMPACTS OF POLICY INTEREST RATE CHANGES

ON FINANCIAL MARKETS IN TURKEY

M.Sc. THESIS

Neslişah BAŞAVCI
(412161017)

Department of Economics

Economics Programme

Thesis Advisor: Assist. Prof. Dr. Mete Han YAĞMUR

JULY 2020
İSTANBUL TEKNİK ÜNİVERSİTESİ  SOSYAL BİLİMLER ENSTİTÜSÜ

TÜRKİYE’DE POLİTİKA FAİZİ DEĞİŞİKLİKLERİNİN

MALİ PİYASALAR ÜZERİNDEKİ ETKİLERİ

YÜKSEK LİSANS TEZİ

Neslişah BAŞAVCI
(412161017)

Ekonomi Anabilim Dalı

Ekonomi Yüksek Lisans Programı

Tez Danışmanı: Dr. Öğr. Üyesi Mete Han YAĞMUR

TEMMUZ 2020
Neslişah BAŞAVCI, a M.Sc. student of ITU Graduate School of Arts and Social
Sciences student ID 412161017, successfully defended the thesis/dissertation entitled
“THE IMPACTS OF POLICY INTEREST RATE CHANGES ON FINANCIAL
MARKETS IN TURKEY”, which she prepared after fulfilling the requirements
specified in the associated legislations, before the jury whose signatures are below.

Thesis Advisor : Assist. Prof. Dr. Mete Han YAĞMUR ..............................

Istanbul Technical University

Jury Members : Assist. Prof. Dr. Shourjo CHAKRAVORTY ........................

Istanbul Technical University

Assist. Prof. Dr. Yunus ÖZCAN ..............................

Istanbul Commerce University

Date of Submission : 15 June 2020

Date of Defense : 16 July 2020

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FOREWORD

When I was an undergraduate student at Middle East Technical University, my major

was economics and I wanted to continue to specialize in this area at İstanbul Technical
University. Based on this, I applied merely İstanbul Technical University for the
master’s degree and got accepted. Herein, this is the final work of my master’s degree.
I believe that my thesis is going to be an example, give an idea, and contributes to
other papers about the effectiveness of monetary policy in Turkey.
Writing my thesis was not an easy process. So I extremely thank my thesis advisor,
Assist. Prof. Mete Han YAĞMUR for his contribution, patience, and help. Also, I
would like to thank my dear family, mother Özden, father İsmail, brother Batuhan, and
my love Türkiz. This process could not be accomplished without their support.

July 2020 Neslişah BAŞAVCI

vii
viii
TABLE OF CONTENTS

Page

FOREWORD ............................................................................................................ vii

TABLE OF CONTENTS .......................................................................................... ix
ABBREVIATIONS ................................................................................................... xi
SYMBOLS ............................................................................................................... xiii
LIST OF TABLES ................................................................................................... xv
LIST OF FIGURES ............................................................................................... xvii
SUMMARY ............................................................................................................. xix
ÖZET…… ………………………………………………………………………....xxi
INTRODUCTION .................................................................................................. 1
LITERATURE REVIEW...................................................................................... 5
The Expectation Theory ..................................................................................... 5
Taylor’s Rule ...................................................................................................... 6
Previous Studies on Monetary Transmission Mechanism ................................. 7
DATA AND METHODOLOGY......................................................................... 11
Data Sources ..................................................................................................... 11
Variables........................................................................................................... 11
Descriptive Statistics of the Data ..................................................................... 16
Hypothesis ........................................................................................................ 17
Methodology .................................................................................................... 18
EMPIRICAL RESULTS ..................................................................................... 25
CONCLUSION..................................................................................................... 29
REFERENCES ......................................................................................................... 31
APPENDIX ............................................................................................................... 35
APPENDIX A ........................................................................................................ 36
CURRICULUM VITAE .......................................................................................... 39

ix
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ABBREVIATIONS

CBRT : Central Bank of the Republic of Turkey

CLT : Central Limit Theorem
EUR : Euro
EVDS : Electronic Data Delivery System
Fed : Federal Reserve System
GDP : Gross Domestic Product
IMF : International Monetary Fund
LON : Late Liquidity Window
MPC : Monetary Policy Committee
MTM : Monetary Transmission Mechanism
OLS : Ordinary Least Squares
OMO : Open Market Operations
O/N : Overnight
TRY : New Turkish Lira
USA : United States of America
USD : United States Dollar
VAR : Vector Autoregression
WEO : World Economic Outlook

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xii
SYMBOLS

 : Constant term
βt : Coefficient at time t
e : Exchange rate
Ɛt : Error term at time t
i : Short-term interest rate
ia : Anticipated component of interest rate
iu : Unanticipated component of interest rate
ie : Expected short-term interest rate
Δ : Change
π : Inflation
π* : Inflation target
n : Number of periods
r* : Long-term real interest rate
R : Treasury bond and bill rates
RFF : Fed’s Target Rate
t : Time
y : Real GDP
y* : Potential GDP
Y : Yield

xiii
xiv
LIST OF TABLES

Page

Table 3.1 : Descriptive statistics of O/N lending interest rates. ................................ 17

Table 3.2 : Actual, anticipated, and unanticipated components of O/N lending
interest rates. ........................................................................................... 23
Table 4.1 : The reactions of O/N lending interest rates changes to 6-month
maturity treasury bond yields ................................................................. 26
Table 4.2 : The reactions of O/N lending interest rates changes to 12-month
maturity treasury bond yields ................................................................. 26
Table 4.3 : The reactions of O/N lending interest rates changes to 24-month
maturity treasury bond yields ................................................................. 27
Table 4.4 : The reactions of O/N lending interest rates changes to percentage
change in the value of USD against the TRY selling rates..................... 28
Table 4.5 : The reactions of O/N lending interest rates changes to percentage
change in the value of EUR against the TRY selling rates..................... 36

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xvi
LIST OF FIGURES

Page

Figure 1.1 : Monetary transmission mechanism (Cambazoğlu and Güneş, 2011). .... 1
Figure 3.1 : O/N lending and borrowing interest rates in Turkey from january 2010
to june 2018 ............................................................................................ 12
Figure 3.2 : 1-month maturity treasury bond yields in Turkey from january 2010
to june 2018. ........................................................................................... 13
Figure 3.3 : 6-month maturity treasury bond yields in Turkey from january 2010
to june 2018. ........................................................................................... 14
Figure 3.4 : 12-month maturity treasury bond yields in Turkey from january 2010
to june 2018. ........................................................................................... 14
Figure 3.5 : 24-month maturity treasury bond yields in Turkey from january 2010
to june 2018. ........................................................................................... 15
Figure 3.6 : USD/TRY daily selling rates from january 2010 to june 2018. ............ 15
Figure 3.7 : EUR/TRY daily selling rates from january 2010 to june 2018. ............ 16
Figure 3.8 : The unanticipated component of O/N lending interest rates from
january 2010 to june 2018. ..................................................................... 20
Figure A.1 : The figures of the unanticipated component, treasury bonds yields
and the percentage changes in the value of USD and EUR against the
TRY (in case of O/N lending interest rate changes) … .......................... 36

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THE IMPACTS OF POLICY INTEREST RATE CHANGES ON FINANCIAL
MARKETS IN TURKEY

SUMMARY

Monetary transmission mechanism (MTM) is one of the central topics in

macroeconomics. It explains how monetary policy decisions affect economic variables
such as aggregate output, employment, and inflation. There are numerous studies on
this subject, especially for developed countries. When the Turkish economy is
considered, it is seen that Turkey is a small open economy and it has been going
through a structural transformation process since the 2001 financial crisis.
MTM is also affected by this transformation process. So there is a need to analyze the
effectiveness of MTM on financial markets for the Turkish economy.
An empirical study is conducted by using Ordinary Least Squares (OLS) regressions
in STATA program. The reason behind using OLS regressions is that policy interest
rates are not announced within certain time intervals. This means policy interest rates
announcement dates cannot be classified as monthly. This results in having jump
variables and no continuous movements in the data. Hence, this subject is researched
by using OLS regressions.
In this study, exogenous variables are selected as policy interest rates since the interest
rate is one of the most important tools in MTM. In this context, overnight (O/N)
interest rates are used as exogenous variables. On the other side, endogenous variables
are treasury bonds yields and exchange rates. Because policy interest rates are applied
to only commercial banks and policy interest rates indirectly stimulate the economy
through financial markets. 6-, 12-, 24-month maturity treasury bonds yields, United
States dollar (USD) and Euro (EUR) against the New Turkish Lira (TRY) are used as
endogenous variables.
Herein, the impacts of MTM on financial markets in Turkey are examined by testing
the reactions of O/N lending interest rates to 6-, 12-, 24-month maturity treasury bonds
yields and percentage changes in the value of USD, EUR against the TRY from
January 2010 to June 2018 in Turkey. In order to analyze this relationship properly,
changes in policy interest rates are decomposed into anticipated and unanticipated
(surprise) components. By doing so, expectations and unexpected portions of
monetary policy decisions are observed clearly.
Our empirical results suggest that the unanticipated component of policy interest rates
has a greater effect than the anticipated component of policy interest rates on treasury
bonds yields in the same direction. Nevertheless, the unanticipated component does
not have a strong effect on treasury bonds yields since coefficients of the unanticipated
component are not large. Besides, the reactions of policy interest rates changes are
stronger on short-run maturity treasury bonds yields and the effectiveness of policy
interest rates changes decreases as maturities get longer. On the other side, the
anticipated component slightly affects treasury bonds yields, except for the treasury
bond yield with 6-month maturity, in the same direction. Lastly, there is no apparent

xix
relationship between policy interest rates changes and exchange rates. The reason
might be that exchange rates are affected by other economic variables such as
investment, trade openness, capital flows, economic growth rate, external debt as well
as political factors.

xx
 TÜRKİYE’DE POLİTİKA FAİZİ DEĞİŞİKLİKLERİNİN MALİ
PİYASALAR ÜZERİNDEKİ ETKİLERİ

ÖZET

Parasal aktarım mekanizması, makroekonomideki önemli konulardan birisidir. Parasal

aktarım mekanizması, para politikası kararlarının toplam çıktı, istihdam ve enflasyon
gibi ekonomik değişkenleri nasıl etkilediğini açıklamaktadır. Özellikle gelişmiş
ülkeler için bu konuda birçok çalışma mevcuttur. Türkiye ekonomisine bakıldığında,
küçük ve açık bir ekonomiye sahip olan Türkiye’nin 2001 yılı finansal krizinden beri
yapısal dönüşüm sürecinde olduğu görülmektedir.
Parasal aktarım mekanizması da bu dönüşüm sürecinden etkilendiğinden, Türkiye
ekonomisi için parasal aktarım mekanizmasının mali piyasalar üzerindeki etkisini
analiz etmek önem arz etmektedir.
Bu tezdeki ampirik çalışma, Sıradan En Küçük Kareler yöntemi kullanılarak STATA
programında yapılmıştır. Sıradan En Küçük Kareler yöntemini kullanmamın nedeni
politika faizlerinin belirli zaman aralığında açıklanmamasıdır. Başka bir deyişle,
politika faizi kararları aylık gibi belirli bir periyotta sınıflandırılamamaktadır. Bu
durum, veri setinde kesikli değişkenlerin olmasına ve sürekliliğin gerçekleşmemesine
neden olmaktadır. Sonuç olarak bu konu Sıradan En Küçük Kareler yöntemi
uygulanarak çalışılmıştır.
Faiz kanalı, parasal aktarım mekanizmasında kullanılan en önemli araçlardan birisi
olduğu için bu tezdeki bağımsız değişkenler politika faiz oranları olarak belirlenmiştir.
Bu kapsamda bağımsız değişken olarak gecelik faiz oranları kullanılmıştır. Diğer
taraftan bağımlı değişkenler ise hazine bonoları getirileri ile döviz kurlarıdır. Çünkü
politika faizleri sadece ticari bankalara uygulanmaktadır ve ekonomiyi mali piyasalar
üzerinden dolaylı olarak etkilemektedir. 6, 12, 24 ay vadeli hazine bonoları getirileri
ile Türk Lirası karşısında Amerikan Doları ile Avro değerleri bağımlı değişkenler
olarak kullanılmıştır.
Türkiye’de parasal aktarım mekanizmasının mali piyasalar üzerindeki etkisi, gecelik
borç verme faiz oranlarının 6, 12, 24 ay vadeli hazine bonosu getirileri ile Amerikan
Doları ve Avro’nun Yeni Türk Lirası karşısındaki yüzdelik değişimi üzerinden
incelenmiştir. Bu çalışma, Ocak 2010 ile Haziran 2018 periyodunu kapsamaktadır.
Ayrıca bu etkiyi uygun bir şekilde gözlemleyebilmek için politika faizi değişimleri
beklenen ve beklenmeyen (sürpriz) kısım olarak ayrıştırılmıştır. Bu şekilde para
politikası kararlarının beklenen ve beklenmeyen etkileri net bir şekilde
gözlemlenmiştir.
Ampirik çalışmalarımız, politika faizlerinin beklenmeyen kısmının beklenen kısma
kıyasla hazine bonoları getirilerinde daha etkili olduğunu ortaya koymaktadır. Yine de
beklenmeyen kısmın katsayıları büyük olmadığı için hazine bonoları getirileri
üzerinde çok ciddi bir etkisi bulunmamaktadır. Ayrıca politika faizindeki değişimler,
kısa vadeli hazine bonosu getirilerinde daha etkilidir ve bu etki, hazine bonolarının

xxi
vadeleri uzadıkça azalmaktadır. Diğer taraftan beklenen kısım, hazine bonoları
getirileri (6 ay vadeli hazine bonosu getirileri hariç) üzerinde çok az ve aynı yönde bir
etkiye sahiptir. Son olarak politika faizindeki değişimler ile döviz kurları arasında net
bir ilişki bulunamamıştır. Bunun sebebi döviz kurlarının yatırım, ticari açıklık,
sermaye akışı, ekonomik büyüme oranı, dış borçlar gibi birçok ekonomik
değişkenlerden ve bazı siyasi faktörlerden etkilenmesi olarak düşünülebilmektedir.

xxii
 INTRODUCTION

Policymakers use fiscal and monetary policy instruments in order to sustain economic
stability. The ultimate objectives of policymakers are to sustain high economic growth,
a high level of employment, and price stability. Monetary transmission mechanism
(MTM) is the process that demonstrates the reactions of monetary policy decisions to
economic variables such as aggregate demand, inflation, and gross domestic product
(GDP). MTM takes place through several channels, which are interest rates, asset
prices, money and credits, expectations and credibility, and exchange rate channels
(see Figure 1.1). Because central banks have monopoly power on money supply
through open market operations (OMO), the interest rate is one of the most important
channels of MTM. In other words, central banks can directly change the money supply
through OMO and this settles short-term interest rates. For instance, in order to
stimulate economic activities, central banks may decide to follow expansionary
monetary policies and conduct these policies by buying bonds from the market through
OMO. This leads to an increase in the money supply and a decrease in short-term
interest rates. In turn, long-term interest rates decrease. A reduction in long-run interest
rates causes a rise in investment and consumption, which raises GDP. To sum up,
monetary policy decisions about interest rates affect economic activities and overall
income in the long-run. This is how central banks process MTM through their channels
in order to reach their ultimate objectives.

Figure 1.1 : Monetary transmission mechanism (Cambazoğlu and Güneş, 2011).

1
Nevertheless, MTM works under certain assumptions; for MTM to work effectively
the following conditions must be fulfilled:

 Central banks have monopoly power on the money supply and so short-term
interest rates.

 Central banks can affect the money supply through OMO.

 There is nominal rigidity, which means prices and wages are sticky. Thus, they do
not give reaction suddenly when the money supply and/or interest rates change.

 There is no neutrality of money. In other words, changes in the money supply can
affect nominal and real variables.

 The expectation theory is valid for interest rates.

Having explained the theoretical background of MTM, let’s now move on to

motivation for analyzing MTM in Turkey. Although decreasing economic fragility and
rising economic reliability are aimed since the 2001 financial crisis, the effectiveness
of monetary policy is still one of the main debates for small open emerging market
economies like Turkey. According to Başçı et al. (2008) “Small open emerging market
economies are typically characterized by high exchange rate pass-through, asset and
liability dollarization, currency and maturity mismatches in balance sheets of banks
and firms, external financing constraints, and fiscal dominance” (p. 475). Thus, the
impacts of monetary policy on financial markets are blurred and the question “whether
monetary policy is actually effective or not” arises. Besides, analyzing the effects of
monetary policy decisions on financial markets is crucial to determine the most
effective policy actions from the Central Bank of the Republic of Turkey (CBRT)’s
point of view. In addition, forecasting the impacts of monetary policy decisions on
financial markets is necessary for financial market participants because they take
investment decisions and manage risks based on their estimations. Accordingly, this
thesis focuses on the impacts of policy interest rates changes on financial markets in
Turkey. The analysis for this research is conducted using the data from January 2010
to June 2018. The selection of this time period has two main reasons. First, most of the
studies on the effectiveness of policy interest rates changes on financial markets in
Turkey are studied before the 2008 Global Financial Crisis. For example, Aktaş et al.
(2009) study on this subject from December 2004 to August 2008. Also, İnal (2006)
studies on this topic from July 2001 to March 2006. Therefore, these articles represent

2
the effectiveness of monetary policy decisions for the pre-global financial crisis period.
Differing from these studies, this thesis aims to research the effectiveness of monetary
policy decisions for the post-global financial crisis period. This explains why the
analysis starts from January 2010. Second, overnight (O/N) interest rates have not been
used as policy interest rates since June 2018. Hence, the end date of our data analysis
is June 2018.

Within this scope, the reactions of changes in O/N lending interest rates on financial
markets, which are 6-, 12-, 24-months maturity treasury bonds yields and percentage
changes in the value of United Stated dollar (USD), Euro (EUR) against the New
Turkish Lira (TRY) are analyzed.

In empirical studies, changes in O/N lending interest rates are divided into anticipated
and unanticipated components in order to get accurate results. This is due to the fact
that expectations of policy interest rates changes are reflected in prices even before
changes in policy interest rates are announced. This means that reactions to policy
interest rates changes take place before they are announced, and decomposing policy
interest rates changes into the anticipated and the unanticipated components enables
observing total reactions and sources of policy interest rates changes clearly.

In this process, Ordinary Least Squares (OLS) regressions are used since policy
interest rates are not announced monthly, which causes having jump variables in the
dataset. As a result, the impacts of O/N lending interest rates on 6-, 12-, 24-month
maturity treasury bonds yields also percentage changes in the value of USD and EUR
against the TRY are tested by doing f-test and t-test.

Based on empirical results, the unanticipated component has larger coefficients than
the anticipated component on treasury bonds yields, also it affects all treasury bonds
yields in the same direction. In addition, as the maturities of treasury bonds yields are
extended, the effectiveness of the unanticipated component decreases. Apart from this,
the anticipated component has small and positive effects on all treasury bonds yields,
except for the treasury bond yield with 6-month maturity. Finally, there is no clear
relationship between policy interest rates and exchange rates. This may be due to the
fact that exchange rates are influenced by several other variables. In this regard, for
instance, Kılıçarslan (2018) reports that exchange rates volatilities are determined by

3
domestic and foreign investment, money supply, trade openness, GDP, and
government expenditure for the Turkish economy.

The rest of this thesis is organized as follows. The following section reviews the
literature. Section 3 presents data and methodology. Section 4 shows the empirical
studies. Finally, section 5 concludes the analysis and offers some suggestions for future
works.

4
 LITERATURE REVIEW

From the point of a theoretical framework, monetary policy affects financial markets
through monetary policy instruments such as policy interest rates. Hildebrand (2006)
also reports that “financial markets are the connecting link in MTM between monetary
policy and the real economy”. The effectiveness of monetary policy on the real
economy is described based on the theoretical framework. However, in practice, the
reactions of monetary policy to the real economy may be different in developed
countries and developing countries. According to Kelilume (2014), “the relative
effectiveness of monetary policy in developing countries and emerging market
economies has been less successful because of the unsophisticated nature of the money
market in most of the economies” (p.45). In this thesis, the effectiveness of monetary
policy for the Turkish economy is the focal point. Based on World Economic Outlook
(WEO) Database (2018) by International Monetary Fund (IMF), Turkey is an
emerging and developing economy. As a result, in order to observe whether monetary
policy has an effect on financial markets or not, the impacts of monetary policy
changes on financial markets ought to be researched for the Turkish economy.

To analyze the effects of policy interest rates changes on financial markets clearly, the
relationship between short-term and long-term interest rates is needed to be stated at
first. Herein, the expectation theory and Taylor’s rule are two important principles to
investigate the relationship between short-term and long-term interest rates. Therefore,
these two theories are explained below.

The Expectation Theory

According to the expectation theory, long-term interest rates depend on short-term

interest rates and expectations about future short-term interest rates. Therefore, long-
term interest rates are adjusted in response to changes in short-term interest rates
and/or expectations about future short-term interest rates. Besides, according to
arbitrage opportunity, two equal investment options should provide the same amount
of return. As a result, monetary policy decisions have effects on short-term interest

5
rates and expectations about future short-term interest rates, which cause changes in
long-term interest rates at the end. Based on the expectation theory framework, the
expected return of holding bonds at time t is calculated with the equation 2.1.

int = 1/n.(it + ie t+1 + ie t+2 + …. + ie t+(n-1)) + Ɛt (2.1)

In the formula, n shows the number of periods, ie represents expected future short-term
interest rate, and Ɛt is the error term at time t. Assume that, there is a one-year bond
with no risk premium, its current rate is 8% and investors expect the interest rate to be
10% next year. In this case, the expected return of holding the bond for two years is
(1/2) x (8% + 10%) + 0 = 9%.

Taylor’s Rule

In his seminal paper, Taylor (1993) developed an interest rate decision rule for
monetary policymakers. According to this rule, short-term interest rates are based on
inflation and output targets in an economy. Taylor’s rule describes that central banks
should rise short-term interest rates when inflation is above its target and/or GDP
growth is above its potential. On the other hand, central banks should lower short-term
interest rates when inflation is below its target and/or GDP growth is below its
potential. The logic behind this rule is that an increase in demand leads to a rise in
price and output gap, in turn inflation raises. Herein, the CBRT should increase short-
term interest rates in order to decrease current inflation to its target also achieve and
maintain price stability. Because a rise in short-term interest rates decreases
consumption and investment, this causes a reduction in demand and so inflation
reaches to its long-run target. As a result, Taylor’s rule aims to forecast short-term
interest rates and apply monetary decisions effectively in order to reach and maintain
targets for long-run inflation and output.

it = πt + r*t + βπ (πt – π*t) + βy (log yt – log y*t) (2.2)

Here, i is the short-term nominal interest rate, π is the inflation, r* is the long-term
real interest rate, π* is the inflation target, y is the real GDP, y* is the potential GDP.
Also β’s are coefficients and they should be positive numbers. βπ represents sensitivity
of the short-term nominal interest rate to the inflation deviation from its target and βy

6
shows sentivity of the short-term nominal interest rate to the deviation of real GDP
from its target. Taylor (1993) reports βπ and βy as 0.5.

Previous Studies on Monetary Transmission Mechanism

There are numerous articles on the impacts of MTM on financial markets. In this
section, empirical studies by Cook and Hahn (1988), Roley and Sellon (1995), and
Kuttner (2001) are explained.

Cook and Hahn (1988) investigate the reactions of changes in the Federal Reserve
System’s (Fed) target rate on financial markets in the United States of America (USA)
from September 1974 to September 1979. In this study, 3-, 6-, and 12-month maturity
treasury bill rates and 3-, 5-, 7-, 10-, and 20-year maturity bond rates are used as
financial markets instruments. The Fed’s target rate changes 76 times in this period.
Changes in the Fed’s target and reactions of treasury bills and bond rates are calculated
by one-day reaction. The main regression equation used in this study as follows:

ΔRt =  + β1 ΔRFFt + Ɛt (2.3)

ΔRFFt shows the change in the Fed’s target rate, ΔRt is the change in treasury bond and
bill rates on the day of the target rate change.

The authors find that changes in the Fed’s target rate are effective on short-term,
medium-term, and long-term interest rates in the same direction. Also the effectiveness
of the Fed’s target rate on treasury bond and bill rates is strong on short-term interest
rates, moderate on medium-term interest rates, and small on long-term interest rates.
Therefore, the Fed has an effect on market interest rates through its target interest rates.
In addition, expectations have little effect on treasury bond yields in the analysis.

Roley and Sellon (1995) also analyze the effectiveness of monetary policy in the USA
from October 1987 to July 1995.

Although Roley and Sellon (1995) use the same method for the same economy with
Cook and Hahn (1988), they get different empirical results. The authors suggest that
financial market participants may have different expectations according to time period
and business cycle, which is affected by ongoing monetary policy actions. So this
results in observing different relationships between policy actions and long-term
interest rates. Apart from this, the reactions of changes in long-term interest rates are

7
found weak since Roley and Sellon (1995) report that the impacts of policy actions on
long-term interest rates strictly depend on expectations of financial market participants
for the future monetary policy changes.

The effectiveness of monetary policy actions on market interest rates is researched by

Kuttner (2001) as well but in a different way. According to the author, the previous
studies have weaknesses with the methodology. Kuttner (2001) claims that major
weaknesses with the previous studies are that only raw changes in the Fed’s funds rate
target are used in testing and there is no consideration on the expectancy of monetary
policy changes by financial market participants. But expectations play an important
role in the effectiveness of monetary policy in practice. As a result, Kuttner (2001)
mentions that Cook and Hahn (1988), Roley and Sellon (1995) fail to observe the close
relationship between monetary policy actions and long-term interest rates.
Consequently, Kuttner (2001) explains that there is a need to decompose policy
interest rates changes into anticipated and unanticipated (surprise) components.
Although expectations are difficult to measure statistically, Kuttner (2001) formalizes
the main equation and the anticipated component of policy interest rates changes as
seen below.

The main equation is described as the following:

ΔRt =  + β1 Δiet + β2 Δiut + Ɛt (2.4)

ΔRt shows changes in yields on 3-, 6-, 12-month maturity bills, 2-, 5-, 10-year notes,
and 30-year bonds while Δiet is the expected component of changes and Δiut is the
unexpected part of changes.

The anticipated component of changes is defined as follows:

Δiet = Δit - Δiut (2.5)

In words, the expected component is the difference between actual changes and the
unexpected component.

According to empirical results, Kuttner (2001) notifies that the unanticipated

component of monetary policy actions is significantly effective while the anticipated
part is slightly effective on market interest rates. This result is consistent with the
expectation theory.

8
Up to now, the theoretical framework of the relationship between short-term and long-
term interest rates also previous studies on MTM have explained. As mentioned above,
not only actual policy interest rates changes but also expectations should be considered
while testing the effects of monetary policy actions. Within this context, we now move
on the empirical studies for the Turkish economy in order to examine the theoretical
framework of monetary policy actions in practice.

9
10
 DATA AND METHODOLOGY

In this section, data sources, variables, descriptive statistics of the variables,

hypothesis, and methodology are explained.

Data Sources

This thesis analyzes the effects of policy interest rates changes on financial markets in
Turkey from January 2010 to June 2018. The reactions to financial markets are tested
by observing reactions to 6-, 12-, 24-month maturity treasury bonds yields and
percentage changes in the value of USD and EUR against the TRY. This analysis is
tested in STATA program. The data source of 1-, 6-, 12-, 24-month maturity treasury
bonds yields is Reuters. The data of O/N interest rates, the values of USD and EUR
against the TRY are obtained from Electronic Data Delivery System (EVDS) of the
CBRT.

Variables

To achieve and sustain price stability is the main aim of the CBRT. In order to attain
this target, one-week repo rates, O/N and late liquidity window (LON) interest rates
are determined and announced by the CBRT. Basically, one-week repo rate is a short-
term agreement that selling securities in order to repurchase with its yield. O/N interest
rates are used to borrow and lend in the overnight market, and LON interest rates are
used to prevent liquidity shortages of banks in the overnight market.

In this thesis, exogenous variables are policy interest rates. Policy interest rates have
two types as borrowing and lending interest rates. Herein, O/N lending interest rates
are chosen as policy interest rate tools and used as exogenous variables. Because O/N
lending interest rates change more than O/N borrowing interest rates between January
2010 and June 2018. In this period, Monetary Policy Committee (MPC) held 31
meetings to announce policy interest rates. In this period, there are 27 changes in O/N
lending interest rates while 13 changes in O/N borrowing rates (see Figure 3.1). Hence,

11
O/N lending interest rates provide more variability and so they are used as exogenous
variables in this study.

18
O/N Borrowing
16 O/N Lending

14

12
Interest Rates (%)

10

0
Sep-10

Feb-12
Sep-12

Feb-13
Mar-13

Feb-15
Mar-16

Sep-16
Oct-10

Oct-11

Oct-12

May-13

May-16
Dec-10

Apr-13

Apr-16

Jun-16

Jun-18
Jan-10

Nov-10

Aug-11

Nov-12
Jan-13

Jul-13
Aug-13
Jan-14
Jul-14
Aug-14

Jul-16
Aug-16

Nov-16
Jan-17
Figure 3.1 : O/N lending and borrowing interest rates in Turkey from january 2010
to june 2018.

The impacts of policy interest rates changes on financial markets are observed by the
effects on treasury bonds yields with different maturities and exchange rates in this
study. Herein, endogenous variables are 6-, 12-, 24-month maturity treasury bonds
yields, and percentage changes in the value of USD and EUR against the TRY. Daily
selling rates are used for exchange rates in this study. The reasons behind the selection
of these variables as endogenous are mentioned below.

 O/N interest rates are applied between the CBRT and commercial banks. As a
result, the impacts of O/N interest rates changes are indirectly reflected financial
markets through interest rates, bonds and bills prices, exchange rates, and risk
premium.

 The maturity of treasury bonds lasts up to 30 years and 24-month maturity is

classified as short-term in developed economies. However, 24-month maturity
represents long-run for Turkey as it is a developing economy. Therefore, treasury
bonds yields are selected with 6-, 12-, 24-month maturities in order to observe the

12
 reactions for short-term also long-term. In addition, 1-month maturity treasury
bond yields are only used to calculate the unanticipated component of policy
interest rates changes because Aktaş et al. (2009) report that treasury bonds give
accurate results in forecasting the unanticipated component.

 İnal (2006) emphasizes that treasury bonds are the most liquid and safe investment
instruments. So expectations about interest rates changes can be observed through
treasury bonds yields clearly.

 The values of USD and EUR against the TRY are selected as endogenous variables
to measure the reactions of O/N interest rates changes since they are the most
traded currencies in the world as well as in Turkey.

Figures 3.2, 3.3, 3.4, and 3.5 show the values of treasury bonds yields with 1-, 6-,
12-, 24-month maturities on a daily basis, respectively. From January 2010 to June
2018, the highest values of 6-, 12-, 24-month maturity treasury bonds yields are 38,
30, and 30, respectively. On the other side, the lowest values of 6-, 12-, 24-month
maturity treasury bonds yields are 4, 4, and 1, respectively.

40
Open
35
High
30

Low
25
Yield

Close
20

15

10

Figure 3.2 : 1-month maturity treasury bond yields in Turkey from january 2010 to
june 2018.

13
 40
Open
35
High
30
Low
25
Close
Yield

20

15

10

Figure 3.3 : 6-month maturity treasury bond yields in Turkey from january 2010 to
june 2018.

40
Open
35
High
30
Low
25
Close
Yield

20

15

10

Figure 3.4 : 12-month maturity treasury bond yields in Turkey from january 2010 to
june 2018.

14
 40
Open
35
High
30

Low
25
Yield

Close
20

15

10

Figure 3.5 : 24-month maturity treasury bond yields in Turkey from january 2010 to
june 2018.

Figures 3.6 and 3.7 show the values of USD and EUR against the TRY on a daily basis
between January 2010 and June 2018. As seen in Figures 3.6 and 3.7, the values of
USD and EUR against the TRY raise gradually. In this period, the highest values of
USD/TRY and EUR/TRY are 6.89, 7.85, respectively.

8.00

7.00

6.00
Exchange Rate (USD/TRY)

5.00

4.00

3.00

2.00

1.00

0.00

Figure 3.6 : USD/TRY daily selling rates from january 2010 to june 2018.

15
 8.00

7.00

6.00
Exchange Rate (EUR/TRY)

5.00

4.00

3.00

2.00

1.00

0.00

Figure 3.7 : EUR/TRY daily selling rates from january 2010 to june 2018.

To sum up, testing the impacts of MTM on different types of endogenous variables
leads to observe which channel is the most effective on the application of MPC
decisions.

Descriptive Statistics of the Data

In this section, descriptive statistics of the data are presented in Table 3.1. Herein,
6-, 12-, 24-month maturity treasury bonds yields, the anticipated and the unanticipated
components of policy interest rates changes are not raw data since all variables are
calculated by taking averages of opening and closing values on a daily basis. The
reason for using this calculation method is that treasury bonds yields do not have many
outliers as seen in Figures 3.3, 3.4, and 3.5. Table 3.1 shows the reactions to O/N
lending interest rates given by 6-, 12-, 24-month maturity treasury bonds yields, also
the anticipated and the unanticipated components of policy interest rates changes. In
this analysis, the reactions to O/N lending interest rates given by 6-, 12-, 24-month
maturity treasury bonds yields and the unanticipated component of O/N interest rates
changes are calculated by subtracting the average of opening and closing values of the
variables on the day of O/N interest rates announcement from the average of opening
and closing values of the variables one day before the announcement. Besides, the
anticipated component of O/N lending interest rates changes is calculated by
subtracting actual O/N lending interest rates changes from the unanticipated part.

16
According to Table 3.1, 6-month maturity treasury bond yields have a negative mean
while the other variables have positive means. In other words, averages of reactions
given by 6-month maturity treasury bond yields to O/N lending interest rates changes
are negative but close to zero. Therefore, means of 6-month maturity treasury bond
yields’ opening and closing values average are slightly lower on the day of O/N interest
rates announcement in comparison to one day before the announcement. In addition,
the lowest values for all variables are negative as seen in Table 3.1. So this shows how
much averages of opening and closing values of variables are the lowest on the day of
O/N interest rates announcement in comparison to one day before the announcement.
On the other side, the maximum values are positive for all variables. This presents the
maximum values for all variables’ averages of opening and closing values on the day
of O/N interest rates announcement in comparison to one day before the
announcement. Finally, the lowest and the maximum values are observed in the
anticipated component as presented in Table 3.1.

Table 3.1 : Descriptive statistics of O/N lending interest rates.

Variable Mean Std. Dev. Min Max

Anticipated 0.23 1.69 -1.42 7.33
Unanticipated 0.01 0.26 -0.39 1.03
6-MMTBY -0.01 0.21 -0.56 0.60
12-MMTBY 0.01 0.20 -0.30 0.63
24-MMTBY 0.02 0.16 -0.22 0.54

Hypothesis

After explaining variables and their descriptive statistics, hypotheses are mentioned in
this section. This thesis aims to analyze the impacts of policy interest rates changes on
financial markets in Turkey from January 2010 to June 2018. It is researched as the
impacts of O/N lending interest rates changes on 6-, 12-, 24-month maturity treasury
bonds yields also percentage changes in USD and EUR against the TRY. Herein,
changes in O/N lending interest rates are separated into the anticipated and the
unanticipated components in order to observe the reasons of policy changes clearly.
As a result, null hypothesis of the analysis is that 6-, 12-, 24-month maturity treasury
bonds yields and percentage changes in the value of USD and EUR against the TRY
do not react to O/N lending interest rates changes. Hence null hypotheses of the
analysis are as the following:

17
Ha: The unanticipated and the anticipated components of O/N lending interest rates
changes do not have effects on 6-month maturity treasury bond yields in Turkey from
January 2010 to June 2018.

Hb: The unanticipated and the anticipated components of O/N lending interest rates
changes do not have effects on 12-month maturity treasury bond yields in Turkey from
January 2010 to June 2018.

Hc: The unanticipated and the anticipated components of O/N lending interest rates
changes do not have effects on 24-month maturity treasury bond yields in Turkey from
January 2010 to June 2018.

Hd: The unanticipated and the anticipated components of O/N lending interest rates
changes do not have effects on percentage changes in the value of USD against the
TRY selling rates in Turkey from January 2010 to June 2018.

He: The unanticipated and the anticipated components of O/N lending interest rates
changes do not have effects on percentage changes in the value of EUR against the
TRY selling rates in Turkey from January 2010 to June 2018.

Methodology

This section presents the methodology used in testing the impacts of policy interest
rates changes on financial markets in Turkey from January 2010 to June 2018.
Although empirical studies on the effectiveness of monetary policy are tested by using
Vector Autoregression (VAR) model in general, there are several debates on the
usefulness of VAR model to test monetary policy shocks. Evans and Kuttner (1998)
specify three main reasons for the inefficiency of VAR approach to analyze monetary
policy. First, they report that VAR approach forecasts poorly because of the weak
correlation between the VAR forecast errors and the futures market errors. They
mention that the forecast’s volatility is more than the future market’s volatility and this
causes getting low correlation. Second, estimations with VAR model can be noisy.
This means VAR model includes too much and unnecessary information in their
analysis. However, the authors explain that this problem can be prevented by revising
the data. Third, the most critical issue about the inefficiency of VAR approach is a
time aggregation problem. More clearly, the Fed’s funds market can misrepresent the
timing and magnitude of policy shocks. When average data is used in the analysis, the

18
timing deviates but the magnitude is observed right. On the other side, when point-in-
time data is used the timing is observed correctly, however the magnitude distorts.
Besides, Kuttner (2001) explains that monetary policy reacts to information received
within a certain time period and some part of the unanticipated component does not
correspond exactly to policy shocks in VAR model. Hence, these main findings
indicate that monetary policy changes should not be analyzed with VAR approach.

Apart from this, as presented in Table 3.2, policy interest rates are not announced
within certain time intervals. For this reason, the data have no continuous movements
and this means that the data are not time series. Since the data are not continuous,
heteroscedasticity, autocorrelation, unit root, and cointegration tests cannot be done.
Nevertheless, if we could test for the stationarity, exchange rates regressions would be
stationary because we already took first differences of exchange rates by calculating
their percentage changes. In case O/N lending interest rates change, the reactions of
the unanticipated component to treasury bonds yields with 6-, 12-, 24-month
maturities and percentage changes in the value of USD and EUR against the TRY are
all stationary although there are some outliers. These findings are clearly presented in
Appendix A. According to the graphs in Appendix A, when O/N lending interest rates
change, observations distribute close to regression lines. In other words, the
relationships between the unanticipated component and 6-, 12-, 24-month maturity
treasury bonds yields, percentage changes in the value of USD and EUR against the
TRY are steady, although there are some outliers. Besides, as seen in Figure 3.8, the
unanticipated component of O/N lending interest rates fluctuates around 0.5, except
for the value in October 2011, which is the only outlier in the data.

19
 1.00 Unanticipated Component
Unanticipated Component

0.50

0.00
Sep-10

Feb-12
Sep-12

Feb-13

Feb-15

Sep-16
Mar-13

Mar-16
Oct-10

Dec-10

Oct-11

Oct-12

May-13

May-16
Nov-10

Aug-11

Nov-12

Apr-13

Aug-13

Aug-14

Apr-16

Jun-16

Aug-16

Nov-16

Jun-18
Jan-13

Jul-13

Jan-14
Jul-14

Jul-16

Jan-17
-0.50

Figure 3.8 : The unanticipated component of O/N lending interest rates from january
2010 to june 2018.

In the light of this information, OLS regressions are used in this thesis in the same way
it is used by Kuttner (2001), İnal (2006), and Aktaş et al. (2009). There are two
important points that make this thesis different from the articles by Kuttner (2001),
İnal (2006), and Aktaş et al. (2009). First, differing from empirical studies by Kuttner
(2001) and İnal (2006), this study analyzes the effects of policy interest rates on
exchange rates, which are selected as USD and EUR against the TRY in this study.
Second, apart from İnal (2006) and Aktaş et al. (2009), this study focuses on the
impacts of policy interest rate decisions after the 2008 Global Financial Crisis for the
Turkish economy.

Kuttner (2001), İnal (2006), and Aktaş et al. (2009) explain that policy interest rates
changes should be divided into the anticipated and the unanticipated components.
Because according to the expectation theory, the anticipated component of policy
interest rates changes is expected to have a slight or no effect on interest rates, however
the unanticipated component of policy interest rates changes is expected to have a
strong effect on interest rates. As a result, decomposing policy interest rates changes
into the anticipated and the unanticipated parts provides to observe the effects and
reasons of monetary policy changes properly.

20
The main regression equation that this study would like to test is the following:

ΔYt =  + β1 iat + β2 iut + Ɛt (3.1)

In this formula, ΔYt represents the difference between yields on the day of O/N lending
interest rates announcement and one day before the announcement for 6-, 12-, 24-
month maturity treasury bonds. Also, ΔYt shows percentage changes in difference
between values on the day of O/N lending interest rates announcement and one day
before the announcement for the value of USD and EUR against the TRY.  is a
constant term, iat is the anticipated part of O/N lending interest rate changes, iut is the
unanticipated portion of O/N lending interest rates changes, and Ɛt is an error term.

The unanticipated component is calculated for all regressions as follows:

iut = it - it-1 (3.2)

where iut is the unanticipated component of O/N interest rates changes. it is the average
of 1-month maturity treasury bond yields’ opening and closing values on the day of
policy interest rates announcement. it-1 is the average of 1-month maturity treasury
bond yields’ opening and closing values on one day before the announcement. Herein,
the unanticipated component is calculated by using 1-month maturity treasury bond
yields and survey of expectations statistics conducted by the CBRT is not utilized.
Because Aktaş et al. (2009) report that there is no match between the days of policy
interest rate announcements and survey of expectations statistics in general. Based on
this, the authors note that this prevents the accuracy of the unanticipated component
calculation.

Having explained the calculation methods of exogenous variables, we now move on

to endogenous variables, which are treasury bonds and exchange rates. All treasury
bonds, which are 1-, 6-, 12-, 24-month maturities are calculated by taking averages of
opening and closing values of the trading day. This method eliminates the importance
of policy interest rate announcement hour.

21
Changes in the value of USD and EUR against the TRY are calculated as follow:

%Δet = 100.(et – et-1)/et-1 (3.3)

where et represents the exchange rate on the day of policy interest rates announcement
and et-1 shows the exchange rate one day before the announcement.

22
Table 3.2 : Actual, anticipated, and unanticipated components of O/N lending
interest rates.

Date Actual Anticipated Unanticipated

09.17.10 -0.250 -0.240 -0.010

10.15.10 0.000 0.002 -0.002
11.12.10 0.000 0.077 -0.077
12.17.10 0.250 0.346 -0.096
08.05.11 0.000 0.340 -0.340
10.21.11 3.500 2.469 1.031
02.22.12 -1.000 -1.013 0.013
09.19.12 -1.500 -1.422 -0.078
10.19.12 -0.500 -0.471 -0.029
11.21.12 -0.500 -0.468 -0.032
01.23.13 -0.250 -0.152 -0.098
02.20.13 -0.250 -0.041 -0.209
03.27.13 -1.000 -1.154 0.154
04.17.13 -0.500 -0.394 -0.106
05.17.13 -0.500 -0.343 -0.157
07.24.13 0.750 0.986 -0.236
08.21.13 0.500 0.280 0.220
01.29.14 4.250 4.245 0.005
07.18.14 0.000 -0.196 0.196
08.28.14 -0.750 -0.843 0.093
02.25.15 -0.500 -0.206 -0.294
03.25.16 -0.250 -0.354 0.104
04.21.16 -0.500 -0.973 0.473
05.25.16 -0.500 -0.362 -0.138
06.22.16 -0.500 -0.496 -0.004
07.20.16 -0.250 -0.410 0.160
08.24.16 -0.250 -0.345 0.095
09.23.16 -0.250 0.137 -0.387
11.25.16 0.250 0.245 0.005
01.25.17 0.750 0.666 0.084
06.01.18 7.250 7.331 -0.081

23
24
 EMPIRICAL RESULTS

In this section, empirical results on the impacts of policy interest rates changes on
financial markets are examined. Specifically, the reactions to O/N lending interest
rates changes are presented. As seen in Table 3.2, MPC announced O/N interest rate
decisions for 31 times from January 2010 to June 2018. In this study, the number of
observations is small, which is the weakness of this study, however it is adequate.
Because the Central Limit Theorem (CLT) states that if the sample size is at least 30,
then the population is normally distributed regardless of its type of distribution. Based
on this, all regressions in this study are with normally distributed data. Apart from this
thesis, Kuttner (2001), İnal (2006), and Aktaş et al. (2009) studied on this subject and
their numbers of observations are 42, 35, and 44, respectively. This shows that some
other studies on this subject do not have a large number of observations as well.

According to Table 3.2, O/N interest rate decisions were announced 31 times from
January 2010 to June 2018, so there are 31 observations for all variables and empirical
results based on these observations are as the following.

First, Table 4.1, 4.2, and 4.3 present the reactions of O/N lending interest rates changes
to treasury bonds yields with 6-, 12-, 24-month maturities. Based on this, the
anticipated component is statistically significant on all treasury bonds yields, except
for 6-month maturity treasury bond yields. Coefficients of the anticipated component
to 12-, 24-month maturity treasury bonds yields are 0.06 and 0.05, respectively.
Therefore, the anticipated component has a slight effect on treasury bonds yields in the
same direction and one-point change in the anticipated component alters 12-, 24-month
maturity treasury bonds yields with 0.06 and 0.05 points, respectively. On the other
side, the unanticipated component is noticeably more effective on treasury bonds
yields. Because it is statistically significant on 6-, 12-, 24-month maturity treasury
bonds yields and coefficients of the unanticipated component are 0.54, 0.49, and 0.33,
respectively. Thus, the unanticipated component affects all treasury bonds yields in
the same direction and its effectiveness on treasury bonds yields decreases when
maturities of treasury bonds yields extend. Earlier studies on this subject by Kuttner
(2001), İnal (2006), and Aktaş et al. (2009) get similar results. The authors report that

25
the unanticipated component is more effective than the anticipated component and its
effectiveness on treasury bonds yields decrease as maturities get longer. In addition,
they all find a weak relationship between the anticipated component and treasury
bonds yields. According to İnal (2006), the reason behind this finding is a rising trend
in the reliability of monetary policy decisions applied after November 2000 and
February 2001 Financial Crises in Turkey.

Herein, empirical results are reliable because the impacts of O/N lending interest rates
changes on 6-, 12-, 24-month maturity treasury bonds yields are explained well since
their adjusted R-squared values are 0.45, 0.67, and 0.61, respectively. At this point, we
primarily focus on adjusted R-squared rather than R-squared values because adjusted
R-squared values explain the proportion of total variation in the dependent variable
explained by independent variables, which only have effects on the dependent
variable, but R-squared values show how much total variation in the dependent
variable is explained by all independent variables.

Table 4.1 : The reactions of O/N lending interest rates changes to 6-month maturity
treasury bond yields.

Variable Coefficient Std. Error t-value p-value Obs.

Anticipated 0.0184 0.0168 1.10 0.2810 31
Unanticipated 0.5422 0.1099 4.93 0.0000 31
Intercept -0.0142 0.0281 0.51 0.6170 31
R-squared 0.4872 Sum of squares 1.3111
Adj. R-squared 0.4506 Mean squares 0.0437

Table 4.2 : The reactions of O/N lending interest rates changes to 12-month maturity
treasury bond yields.

Variable Coefficient Std. Error t-value p-value Obs.

Anticipated 0.0591 0.0125 4.72 0.0000 31
Unanticipated 0.4908 0.0819 5.99 0.0000 31
Intercept -0.0099 0.0209 -0.47 0.6390 31
R-squared 0.6931 Sum of squares 1.2167
Adj. R-squared 0.6712 Mean squares 0.0406

26
Table 4.3 : The reactions of O/N lending interest rates changes to 24-month maturity
treasury bond yields.

Variable Coefficient Std. Error t-value p-value Obs.

Anticipated 0.0532 0.0109 4.90 0.0000 31
Unanticipated 0.3272 0.0711 4.60 0.0000 31
Intercept 0.0020 0.0182 0.11 0.9120 31
R-squared 0.6370 Sum of squares 0.7754
Adj. R-squared 0.6110 Mean squares 0.0258

Second, Table 4.4 and 4.5 show the reactions of O/N lending interest rates changes to
percentage changes in the value of USD and EUR against the TRY, respectively.
According to these tables, the anticipated and the unanticipated components are both
statistically insignificant on percentage changes in the value of USD and EUR against
the TRY. However, findings about the impacts of O/N lending interest rates changes
on percentage changes in the value of USD and EUR against the TRY are very weak
since their adjusted R-squared values are 0.09 and -0.01, respectively. There may be
several reasons behind having very low adjusted R-squared values for exchange rates
regressions. According to Kılıçarslan (2018), trade openness, financial development,
external debt, fiscal balance, inflation, output, money supply growth, current account
balance, current exchange rate regime, capital flows are the main variables that affect
exchange rate volatility in Turkey. In addition, Geldi (2018) reports that Turkey has a
strong trade deficit, which causes exchange rates to be affected by monetary policy
decisions in the USA. Also the author mentions that not only economic conditions but
also internal political uncertainties affect the values of the TRY and make the TRY
more volatile. In short, not only policy interest rates changes but also several other
economic and political conditions are effective on exchange rates. This results in
having no clear relationship between policy interest rates changes and exchange rates.
Apart from this, Aktaş et al. (2009) study the effectiveness of policy interest rates
changes on exchange rates as well. According to their results, the responses of the
value of USD and EUR against the TRY are 0.09 and 0.08, respectively. They find
that policy interest rates do not have an effect on exchange rates since their coefficients
are close to zero. In that article, the authors mention that the reason behind this finding
might be the positive relationship between risk premium and depreciation of the TRY.
But this is not a reliable result as having very low R-squared values.

27
To sum up, these results are consistent with the expectation theory. Because when O/N
lending interest rates are announced by the CBRT, the reactions of the anticipated
component to financial markets are minimum and the unanticipated component is
statistically significant on all treasury bonds yields, but it is not significant on exchange
rates. As stated before, Turkey has a small, open, and fragile economy, so exchange
rates may be affected by several other conditions.

Table 4.4 : The reactions of O/N lending interest rates changes to percentage change
in the value of USD against the TRY selling rates.

Variable Coefficient Std. Error t-value p-value Obs.

Anticipated -0.1530 0.0762 -2.01 0.0550 31
Unanticipated 0.5572 0.4989 1.12 0.2740 31
Intercept -0.0147 0.1276 -0.12 0.9090 31
R-squared 0.1501 Sum of squares 16.3061
Adj. R-squared 0.0894 Mean squares 0.5435

Table 4.5 : The reactions of O/N lending interest rates changes to percentage change
in the value of EUR against the TRY selling rates.

Variable Coefficient Std. Error t-value p-value Obs.

Anticipated -0.0973 0.0794 -1.23 0.2310 31
Unanticipated 0.2634 0.5196 0.51 0.6160 31
Intercept -0.0329 0.1329 -0.25 0.8070 31
R-squared 0.0563 Sum of squares 15.9286
Adj. R-squared -0.0112 Mean squares 0.5309

28
 CONCLUSION

The CBRT aims to achieve and maintain price stability. To this end, the CBRT applies
several monetary policies, and the policy interest rate is one of its major policy tools.
In this thesis, the impacts of policy interest rates changes on financial markets are
analyzed. Within this scope, O/N interest rates are selected as the policy interest rate.
Therefore, this thesis analyzes the reactions of O/N lending interest rates changes on
6-, 12-, 24-month maturity treasury bonds yields and percentage changes in the value
of USD and EUR against the TRY from January 2010 to June 2018. In this study, the
reactions of policy interest rates changes are observed by decomposing policy interest
rates changes into two parts as anticipated and unanticipated so their effects on
financial markets are tested separately.

Empirical studies are conducted by using OLS regressions. Because O/N interest rates
are not announced within certain time intervals, policy interest rate announcement
dates cannot be classified as monthly. Because of this, there are no continuous
movements in the dataset, and analyses are done by applying f-test and t-test.

According to empirical results, when O/N lending interest rates are announced by the
CBRT, the unanticipated component affects 6-, 12-, 24-month maturity treasury bonds
yields, however it does not have effects on percentage changes in the value of USD
and EUR against the TRY. Also the effectiveness of the unanticipated component
decreases as long as the maturities extend. Apart from this, when O/N lending interest
rates are announced, the anticipated component does not have an effect on 6-month
treasury bond yields and percentage changes in the value of USD and EUR against the
TRY. But coefficients of the anticipated part, which are effective on the dependent
variables, are very small.

In conclusion, these results are consistent with the expectation theory in general. But
there is no adequate finding on the policy interest rates reactions to exchange rates
since their R-squared and adjusted R-squared values are very low. Accordingly, there
is no enough interpretation with the effectiveness of policy interest rates changes on
percentage changes in the value of USD and EUR against the TRY. The reasons behind

29
these findings may be the impacts of several other economic and political conditions
on the value of exchange rates such as foreign capital flows, trade and budget deficits.

As a criticism of this study, the impacts of policy interest rates are analyzed by
comparing values on policy interest rates one day before the announcement date. But
expectations about policy interest rates changes may be priced even one week before
the announcement day, therefore total expectation about policy interest rates changes
may not be observed in this study. As a suggestion for further studies, the effectiveness
of policy interest rates can be tested by comparing weekly average values on policy
interest rates prior to the interest rate announcement day. This calculation method can
contribute to analyze total expectation about policy interest rates more accurately.

30
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APPENDIX

APPENDIX A: The graphs of the unanticipated component, treasury bonds yields

and the percentage changes in the value of USD and EUR against the TRY (in case of
O/N lnding interest rate changes)

35
APPENDIX A

36
37
Figure A.1 : The graphs of the unanticipated component, treasury bonds yields and
the percentage changes in the value of USD and EUR against the TRY (in case of
O/N lending interest rate changes)

38
CURRICULUM VITAE

Name Surname : Neslişah BAŞAVCI

Place and Date of Birth : Sakarya – 23/07/1992

E-Mail : nbasavci@gmail.com

EDUCATION :

 B.Sc. : 2015, Middle East Technical University,

Department of Economics, Economics
 Summer School : 2015, London School of Economics
Department of Economics, Development Economics

PROFESSIONAL EXPERIENCE:

 2018 - 2020 Human Resources Specialist at Toyota Motor Manufacturing Turkey

 2016 - 2017 Budget and Reporting Responsible at Otokar Defense and
Automotive Industry
 2014 - 2015 Student Assistant at Middle East Technical University, Ankara

39