A Model of Two Days: Discrete News and Asset Prices

89 Pages Posted: 30 Sep 2017 Last revised: 20 Mar 2021

See all articles by Jessica A. Wachter

Jessica A. Wachter

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

Yicheng Zhu

University of Pennsylvania - Finance Department

Multiple version iconThere are 2 versions of this paper

Date Written: March 19, 2021

Abstract

Empirical studies demonstrate striking patterns in stock market returns in relation to scheduled macroeconomic announcements. First, a large proportion of the total equity premium is realized on days with macroeconomic announcements, despite the small number of such days. Second, the relation between market betas and expected returns is far stronger on announcement days as compared with non-announcement days. Finally, these results hold for fixed-income investments as well as for stocks. We present a model with rare events that jointly explains these phenomena. In our model, which is solved in closed form, agents learn about a latent disaster probability from scheduled announcements. We quantitatively account for the empirical findings, along with other facts about the market portfolio.

Keywords: rare disasters, regime shifts, learning

JEL Classification: G11, G12

Suggested Citation

Wachter, Jessica A. and Zhu, Yicheng, A Model of Two Days: Discrete News and Asset Prices (March 19, 2021). Jacobs Levy Equity Management Center for Quantitative Financial Research Paper, Available at SSRN: https://ssrn.com/abstract=3044805 or http://dx.doi.org/10.2139/ssrn.3044805

Jessica A. Wachter (Contact Author)

University of Pennsylvania - Finance Department ( email )

The Wharton School
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National Bureau of Economic Research (NBER)

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Yicheng Zhu

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

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