Statistical Methods in Finance 2025

Uncertainty in RBI Communication and Time-Varying Spillovers in India's Financial Markets

By:Bhashkar Kumar Kashyap
IISER Bhopal

This paper studies how uncertainty in the Reserve Bank of India’s communication (RBIC) affects Indian financial markets. We focus on equity returns, the rupee–dollar exchange rate, and government bond returns over the period April 2014 to June 2024. To allow the impact of communication uncertainty to change over time, we use a Bayesian time-varying parameter VAR with stochastic volatility (TVP–VAR–SV), in- stead of a standard VAR with fixed coefficients. We first construct a text-based uncer- tainty index from RBI policy statements using the MPNet transformer model. This index captures how clear or unclear the RBI’s messages are, and how their tone changes across policy meetings. Our results show that when RBIC uncertainty goes up, equity returns tend to fall over the short horizons. In contrast, the effects on the exchange rate and government bond returns are smaller and estimated less precisely. When we compare the TVP–VAR–SV model with a conventional constant-parameter VAR, we find that the time-varying model picks up stronger persistence in the effects of commu- nication uncertainty and some spillovers across markets. This suggests that standard static models may underestimate how far and for how long policy communication un- certainty can influence financial prices beyond the initial announcement window. The findings highlight the importance of clear and consistent RBI communication for limit- ing excess volatility, especially in the equity market, and they provide useful guidance for investors who need to manage risks related to policy uncertainty.