A Model of the Macroeconomic Announcement Premium with Production

Abstract

Empirically, a large fraction of the market equity premium is realized on days with significant macroeconomic announcements, such as the FOMC announcements and the unemployment report. This paper presents a theory and a quantitative model for the macroeconomic announcement premium. Our model accounts for several stylized facts related to the macroeconomic announcement premium: the large equity premium realized upon announcements, the fit of CAPM model on announcement days, and the upward sloping bond announcement premium across maturities. We show that generalized risk sensitivity in preferences is key to generate announcement premiums, and our result holds in both endowment economies as well as production economies.

Keywords: announcement premium, generalized risk sensitivity, production

JEL Classification: D81, G12