The Pre-FOMC Announcement Drift and Private Information: Kyle Meets Macro-Finance

74 Pages Posted: 3 Aug 2020 Last revised: 31 Dec 2021

See all articles by Chao Ying

Chao Ying

Chinese University of Hong Kong

Date Written: July 8, 2020

Abstract

This paper studies the private information explanation for the timing and time series of the pre-
FOMC announcement drift. I document informed trading is in the same direction as the realized
returns in the 24-hour window before FOMC. I extend Kyle’s (1985) model to be the case where
market makers are compensated for the riskiness of assets’ fundamentals. Observing aggregate
order flow, market makers update their belief about the marginal-utility-weighted asset value,
which gradually resolves uncertainty, resulting in an upward drift in market prices. I demonstrate
a strictly positive pre-FOMC announcement drift if and only if market makers require risk
compensation.

Keywords: Pre-FOMC Announcement Drift, Uncertainty Resolution, Private Information, Risk Compensation

JEL Classification: G14, E44, G12

Suggested Citation

Ying, Chao, The Pre-FOMC Announcement Drift and Private Information: Kyle Meets Macro-Finance (July 8, 2020). Available at SSRN: https://ssrn.com/abstract=3644386 or http://dx.doi.org/10.2139/ssrn.3644386

Chao Ying (Contact Author)

Chinese University of Hong Kong ( email )

Cheng Yu Tung Building
12 Chak Cheung Street
Shatin, NT
Hong Kong

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