Fearing the Fed: How Wall Street Reads Main Street

54 Pages Posted: 28 Dec 2017 Last revised: 6 May 2018

See all articles by Tzuo Hann Law

Tzuo Hann Law

University of Pennsylvania

Dongho Song

Johns Hopkins University - Carey Business School

Amir Yaron

University of Pennsylvania -- Wharton School of Business; National Bureau of Economic Research (NBER)

Date Written: April 29, 2018

Abstract

We provide strong evidence of persistent cyclical variation in the sensitivity of stock returns to macroeconomic news announcement (MNA) surprises. When the economy is significantly below trend (output gap is large and negative) and interest rates are not expected to go up, the stock return sensitivity to news is large. On the other hand, stock returns hardly react to news during periods when the economy is near trend (output gap is small) and interest rates are expected to rise. A monetary regime-switching model is shown to have implications consistent with this evidence. Taken together, the phase of the economy and interest rate expectations are key determinants of the cyclicality of the response of the stock market.

Keywords: Macroeconomic news announcements, cyclical return variation, interest rate expectations, phase of business cycle, output gap, return decomposition.

JEL Classification: G12, E30, E40, E50

Suggested Citation

Law, Tzuo Hann and Song, Dongho and Yaron, Amir, Fearing the Fed: How Wall Street Reads Main Street (April 29, 2018). Available at SSRN: https://ssrn.com/abstract=3092629 or http://dx.doi.org/10.2139/ssrn.3092629

Tzuo Hann Law

University of Pennsylvania ( email )

Dongho Song (Contact Author)

Johns Hopkins University - Carey Business School ( email )

Baltimore, MD 20036-1984
United States

Amir Yaron

University of Pennsylvania -- Wharton School of Business ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-898-1241 (Phone)
215-898-6200 (Fax)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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