Recovering the FOMC Risk Premium

54 Pages Posted: 16 Apr 2020 Last revised: 10 Jun 2021

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

Date Written: March 12, 2020

Abstract

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

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/

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