Recovering the FOMC Risk Premium

45 Pages Posted: 16 Apr 2020

See all articles by Hong Liu

Hong Liu

Washington University in St. Louis - Olin Business School; Fudan University - China Institute of Economics and Finance

Xiaoxiao Tang

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics

Guofu Zhou

Washington University in St. Louis - John M. Olin Business School; China Academy of Financial Research (CAFR)

Date Written: March 12, 2020

Abstract

The Federal Open Market Committee (FOMC) meetings have significant impact on market returns. We propose a methodology to recover the risk premium associated with FOMC meetings from option prices. We also estimate the sizes of upward/downward market price jumps after an imminent FOMC meeting. In our empirical analysis, with observed price data for 67 meetings and with data backed out via machine learning for the remaining 109 meetings from 1996 to 2017, we find that the risk premium varies from 15 to 88 basis points (bps), with an average of 38 bps which is consistent with the average realized returns documented in the literature. The average upward jump size is 103 bps, and the average downward jump size is 87 bps.

Keywords: Options, FOMC Meeting, Jumps, Recovery

JEL Classification: G11, G14

Suggested Citation

Liu, Hong and Tang, Xiaoxiao and Zhou, Guofu, Recovering the FOMC Risk Premium (March 12, 2020). Available at SSRN: https://ssrn.com/abstract=3553572 or http://dx.doi.org/10.2139/ssrn.3553572

Hong Liu

Washington University in St. Louis - Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-5883 (Phone)

Fudan University - China Institute of Economics and Finance ( email )

China

Xiaoxiao Tang (Contact Author)

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics ( email )

2601 North Floyd Road
P.O. Box 830688
Richardson, TX 75083
United States

Guofu Zhou

Washington University in St. Louis - John M. Olin Business School ( email )

Washington University
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-6384 (Phone)
314-658-6359 (Fax)

HOME PAGE: http://apps.olin.wustl.edu/faculty/zhou/

China Academy of Financial Research (CAFR)

Shanghai Advanced Institute of Finance
Shanghai P.R.China, 200030
China

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