Quantitative Law Describing Market Dynamics Before and After Interest-Rate Change

Physical Review E, Vol. 81, No. 066121, 2010

16 Pages Posted: 23 Oct 2010 Last revised: 24 Oct 2010

See all articles by Alexander Michael Petersen

Alexander Michael Petersen

University of California Merced, Ernest and Julio Gallo Management Program

Fengzhong Wang

Boston University

Shlomo Havlin

Bar Ilan University

H. Eugene Stanley

Boston University - Center for Polymer Studies

Date Written: June 28, 2010

Abstract

We study the behavior of U.S. markets both before and after U.S. Federal Open Market Committee (FOMC) meetings, and show that the announcement of a U.S. Federal Reserve rate change causes a financial shock, where the dynamics after the announcement is described by an analogue of the Omori earthquake law. We quantify the rate $n(t)$ of aftershocks following an interest rate change at time $T$, and find power-law decay which scales as $n(t-T) \sim (t-T)^{-\Omega}$, with $\Omega$ positive. Surprisingly, we find that the same law describes the rate $n'(\vert t-T\vert)$ of "pre-shocks" before the interest rate change at time $T$. This is the first study to quantitatively relate the size of the market response to the news which caused the shock and to uncover the presence of quantifiable pre-shocks. We demonstrate that the news associated with interest rate change is responsible for causing both the anticipation before the announcement and the surprise after the announcement. We estimate the magnitude of financial news using the relative difference between the U. S. Treasury Bill and the Federal Funds Effective rate. Our results are consistent with the "sign effect," in which "bad news" has a larger impact than "good news." Furthermore, we observe significant volatility aftershocks, confirming a "market underreaction" that lasts at least 1 trading day.

Keywords: interest-rate, Fed, volatility aftershocks, anticipation, surprise

JEL Classification: C32, D82, D84, E43, E44, G14

Suggested Citation

Petersen, Alexander Michael and Wang, Fengzhong and Havlin, Shlomo and Stanley, H. Eugene, Quantitative Law Describing Market Dynamics Before and After Interest-Rate Change (June 28, 2010). Physical Review E, Vol. 81, No. 066121, 2010, Available at SSRN: https://ssrn.com/abstract=1695668

Alexander Michael Petersen (Contact Author)

University of California Merced, Ernest and Julio Gallo Management Program ( email )

School of Engineering
Science & Engineering 2, Suite 315
Merced, CA 95343
United States

Fengzhong Wang

Boston University ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States

Shlomo Havlin

Bar Ilan University ( email )

Ramat Gan
Ramat Gan, 52900
Israel

HOME PAGE: http://havlin.biu.ac.il/

H. Eugene Stanley

Boston University - Center for Polymer Studies ( email )

Boston, MA 02215
United States

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