Beyond the Yield Curve: Understanding the Effect of FOMC Announcements on the Stock Market

42 Pages Posted: 29 Mar 2021

See all articles by Christoph Boehm

Christoph Boehm

University of Texas at Austin

Niklas Kroner

University of Texas at Austin

Date Written: March 25, 2021

Abstract

A large literature uses high-frequency changes in interest rates around FOMC announcements to study monetary policy. These yield changes have puzzlingly low explanatory power for the stock market - even in a narrow 30-minute window. We propose a new approach to test whether the unexplained variation represents monetary policy news or just noise. In particular, we allow for a latent "Fed non-yield curve shock'', which we estimate via a heteroskedasticity-based procedure. Using a test for weak identification, we show that our shock is well identified, that is, the unexplained variation is not just noise. We then go on to show that the shock, signed to increase stock prices, leads to sizable declines in the equity and variance premium, an increase in the 10-year term premium, an increase in short-run inflation expectations, as well as a dollar depreciation against multiple non-safe-haven currencies. Hence, the evidence supports the interpretation that the shock affects risk-appetite and leads to a reverse "flight-to-safety'' effect. Lastly, using a method from the computational linguistics literature, we show that our shock can be linked to specific topics discussed in FOMC statements, suggesting that it reflects written communication by the Federal Reserve.

Keywords: Keywords: Federal Reserve, Monetary Policy, Information Effects, Risk Premia, High-frequency Identification

JEL Classification: E31, E32, E43, E44, E52, E58, G10

Suggested Citation

Boehm, Christoph and Kroner, T. Niklas, Beyond the Yield Curve: Understanding the Effect of FOMC Announcements on the Stock Market (March 25, 2021). Available at SSRN: https://ssrn.com/abstract=3812524 or http://dx.doi.org/10.2139/ssrn.3812524

Christoph Boehm

University of Texas at Austin ( email )

2317 Speedway
Austin, TX 78712
United States

T. Niklas Kroner (Contact Author)

University of Texas at Austin ( email )

2317 Speedway
Austin, TX 78712
United States

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