Recovering the FOMC Risk Premium
61 Pages Posted: 16 Apr 2020 Last revised: 25 Apr 2022
Date Written: April 16, 2022
The Federal Open Market Committee (FOMC) meetings are among the most important economic events. We propose a novel method to recover the FOMC risk premium and drift sizes. Empirically, we find that for the 192 meetings from 1996 to 2019, the FOMC risk premium varies across meetings, from 1 to 326 basis points (bps) with an average of 45 bps. We obtain an out-of-sample R-squared of 7.51% when using the recovered FOMC premium to predict the meeting returns around the announcement. The average predicted upward drift size is 101 bps, and the average predicted downward drift size is 129 bps, matching well with the realized ones.
Keywords: Options, FOMC Meeting, Risk Premium, Drift, Recovery
JEL Classification: G11, G14
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