Recovering the FOMC Risk Premium
54 Pages Posted: 16 Apr 2020 Last revised: 10 Jun 2021
Date Written: March 12, 2020
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 the drift sizes. Empirically, we find that the FOMC risk premium varies from 3 to 326 basis points (bps) for the 192 meetings from 1996 to 2019, 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 return 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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