Recovering the FOMC Risk Premium
45 Pages Posted: 16 Apr 2020
Date Written: March 12, 2020
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: Suggested Citation