Pre-FOMC Announcement Relief

61 Pages Posted: 14 Dec 2018

See all articles by Vitor Martello

Vitor Martello

Parcitas Investmentos

Ruy Ribeiro

Pontifical Catholic University of Rio de Janeiro (PUC-Rio) - Department of Economics; Itaú Asset Management

Date Written: November 2018

Abstract

We show that the pre-FOMC announcement drift in equity returns occurs mostly in periods of high market uncertainty or risk premium. Specifically, this abnormal return is explained by a significant reduction in the risk premium (implied volatility and variance risk premium) prior to the announcement, but only when the risk premium is high, e.g., when it is above its median. Likewise, the magnitude of the FOMC Cycle and other related patterns varies with uncertainty and risk premium. Market uncertainty measures are persistent and are not related to policy uncertainty or expectations. Markets become only marginally stressed in the days prior to the announcement and changes in uncertainty appear to be of lower frequency. We also explain why recent studies suggest that the pre-FOMC drift might have disappeared in the past decade, as this moderation is due to time variation that was also present in older data. Additionally, CAPM only works on FOMC dates when the risk premium is high, e.g., implied vol above its prior median level. The results are robust to different samples and measures of risk premium and uncertainty.

Keywords: Asset Prices; Monetary Policy; FOMC; Pre-Announcement Drift; Risk Premium; Uncertainty

JEL Classification: G12; G14; G18; E52

Suggested Citation

Martello, Vitor and Ribeiro, Ruy, Pre-FOMC Announcement Relief (November 2018). Available at SSRN: https://ssrn.com/abstract=3286745 or http://dx.doi.org/10.2139/ssrn.3286745

Vitor Martello

Parcitas Investmentos ( email )

Brazil

Ruy Ribeiro (Contact Author)

Pontifical Catholic University of Rio de Janeiro (PUC-Rio) - Department of Economics ( email )

Rua Marques de Sao Vicente, 225/206F
Rio de Janeiro, RJ 22453
Brazil

Itaú Asset Management ( email )

São Paulo
Brazil

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