Does More Complex Language in FOMC Decisions Impact Financial Markets?

Abstract

This paper is built around a simple premise that is based on the theoretical models of Harris and Raviv (1993) and Kandel and Pearson (1995). Complex statements are more difficult to interpret and may be construed in different ways by different agents. This creates heterogeneity of beliefs among market participants that manifests in increased market activity. We confirm existing results that show monetary policy surprises have a significant impact on financial markets. Importantly, we demonstrate that linguistic complexity (measured in terms of readability and number of words) of FOMC statements that accompany monetary policy decisions significantly increases the trading volume, and volatility of returns, in stock, bond, and currency markets. We also establish that financial markets are more responsive to monetary policy decisions (and the language of those statements) during recession.

Keywords: Monetary policy decisions, Financial markets, Federal Reserve, Linguistic complexity, FOMC statements

JEL Classification: G1, G10, G12, G14