The announcement of macroeconomic indexes have a profound impact on capital markets. The study of the interaction between macroeconomic information and capital markets is important for understanding the efficiency of macroeconomic information transmission and asset pricing in capital markets.
Hu Xing, Associate Professor at the PBC School of Finance (PBCSF), Tsinghua University, and co-authors Pan Jun (Shanghai Advanced Institute of Finance, Shanghai Jiao Tong University), Wang Jiang (Sloan School of Management, MIT), and Zhu Haoxiang (Sloan School of Management, MIT), have recently found in the paper Premium for Heightened Uncertainty: Explaining Pre-Announcement Market Returns that the heightening and resolution of market uncertainty prior to important macroeconomic announcements can explain the high returns and low variances in the stock market.
It is found that prior to the announcement from FOMC meetings, the stock market yields substantial returns without major increase in conventional measures of risk. This presents a “puzzle” to the simple risk-return connection in most (static) asset pricing models. The paper hypothesizes that the arrival of macroeconomic news, with FOMC announcements at the top of the list, brings heightened uncertainty to the market, as investors cautiously await and assess the outcome. While this heightened uncertainty may not be accurately captured by conventional risk measures, its dissolution occurs during a short time window, mostly prior to the announcement, bringing a significant price appreciation. This hypothesis leads to two testable implications: similar return patterns for other pre-scheduled macroeconomic announcements should be observed. And, to the extent that we can find other proxies for heightened uncertainty, we should also observe abnormal returns accompanying its dissolution. Indeed, the paper finds large pre-announcement returns prior to the releases of Nonfarm Payroll, GDP and ISM index. Using CBOE VIX index as a primitive gauge for market uncertainty, disproportionately large returns on days following large spike-ups in VIX are observed. Akin to the FOMC result, such heightened-uncertainty days occur on average only eight times per year, but account for more than 30% of the average annual return on the S&P 500 index. Inspired by the VIX result, the paper searches for direct evidence of heightened uncertainty using VIX as a proxy and find a gradual but significant build-up in VIX over a window of up to six business days prior to the FOMC announcements.
Based on the innovative modeling of the pre-announcement period through the lens of impact uncertainty, the paper theoretically enriches the asset pricing implications of macroeconomic announcements, with empirical characterization of the joint dynamics of returns and VIX. Understanding the underlying mechanism of macroeconomic information transmission helps improve the efficiency of capital markets and contributes to the sound interaction between the macro economy and capital markets.
About the author:
Hu Xing, Associate Professor at the PBC School of Finance (PBCSF), Tsinghua University. She was an assistant professor in Finance at the University of Hong Kong between 2011 and 2019, and received her Ph.D. in Economics from Princeton University in 2011. She also holds a bachelor's degree in Computer Science from the University of Science and Technology of China, and a master's degree from Northwestern University.
Her research focus is on empirical asset pricing, in particular, liquidity, credit risk, and financial crises. Her work has been published in leading academic journals, such as Journal of Finance, Journal of Financial Economics, Journal of Financial and Quantitative Analysis, and International Review of Finance.
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3290649
