key: cord-0895342-5wp04gmr
authors: Kurov, Alexander; Wolfe, Marketa Halova; Gilbert, Thomas
title: The Disappearing Pre-FOMC Announcement Drift()
date: 2020-09-30
journal: Financ Res Lett
DOI: 10.1016/j.frl.2020.101781
sha: dc6132ec8854d70ea2bef4ff888b1190207cd8b4
doc_id: 895342
cord_uid: 5wp04gmr

(Lucca and Moench, 2015) document large average excess returns in U.S. equities before scheduled Federal Open Market Committee (FOMC) meetings from September 1994 to March 2011, leading to a puzzle not explained by standard asset pricing theory. We extend the sample to December 2019. We find that after first appearing before FOMC announcements accompanied by the Fed Chair press conferences, the pre-FOMC drift essentially disappeared after 2015 in both announcements accompanied by press conferences and announcements not accompanied by press conferences. We discuss a possible explanation for this change: reduced uncertainty.

In their influential paper, Lucca and Moench (2015) BGM find that the pre-FOMC drift is limited to announcements with press conferences.

They attribute this to investors expecting policy decisions and paying more attention before announcements with press conferences than before announcements without press conferences.

They also find that the drift begins at the stock market open of the previous day, earlier than during the LM period.

We extend the sample to December 2019, which allows us to analyze more than eight years since the end of the LM sample. We find that the behavior of pre-FOMC returns has changed during the most recent period. Not only did the pre-FOMC drift disappear in announcements without press conferences as in BGM, since January 2016 the pre-FOMC drift has also substantially weakened in announcements with press conferences. We then show that this decrease in the pre-FOMC drift can be explained by reduced uncertainty about market conditions. Our paper therefore adds to two strands of literature. First, it contributes to our understanding of what happens around the FOMC announcements and second, it contributes to our understanding of the role that uncertainty plays in the financial markets.

Uncertainty continues to raise considerable interest. 1 The standard asset pricing theory says that positive expected excess returns are a compensation for the systematic risk, but research has shown that uncertainty also impacts asset prices. For example, Brown, Harlow, and Tinic (1988) propose the uncertain information hypothesis to explain how investors react to unexpected information: the information increases risk and expected return, causing asset prices to be depressed by uncertainty. 2 Bansal and Yaron (2004) present a theoretical model where the equity premium is partly driven by economic uncertainty: an increase in uncertainty increases the equity premium, which decreases the stock prices.

Uncertainty has been studied to explain the behavior of the stock market around the FOMC meetings. Chen and Clements (2007) show that the VIX decreases on days with FOMC meetings. Vähämaa andÄijö (2011) come to the same conclusion and attribute it to the decisions on monetary policy impacting the stock market uncertainty. Fernandez-Perez and Frijns (2017) confirm the above findings with intraday data (as opposed to daily data) and also relate it to the market uncertainty resolution. Amengual and Xiu (2018) find that downward volatility jumps are correlated with monetary policy uncertainty resolution following from FOMC announcements and the Fed Chair speeches. Gu, Kurov, and Wolfe (2018) distinguish between FOMC meetings with and without press conferences and show that uncertainty is higher on the days when the meeting is accompanied by a press conference.

Uncertainty has also received attention in explaining the pre-FOMC drift documented by LM and BGM. Hu, Pan, Wang, and Zhu (2019) argue that the drift arises because there are two types of risks related to scheduled announcements. The first type is due to the uncertain content of the news itself and is therefore directional. The second type is due to elevated 1 In recent literature, for example, Goodell, McGee, and McGroarty (2020) study the relationship between financial market uncertainty, economic policy uncertainty, and election uncertainty in U.S. presidential elections and find that the incumbent-party election probability explains changes in the financial market uncertainty.

2 The uncertain information hypothesis has been supported by, for example, Pantzalis, Strangeland, and Turtle (2000) using international stock market data around elections. uncertainty in anticipation of the scheduled announcement and its impact. They show that it is resolution of the second type of risk before the announcement that causes the positive pre-announcement drift. 3 Our paper builds on this literature by showing that the pre-FOMC drift documented by LM and BGM has declined in not only announcements without press conferences but also announcements with press conferences and its disappearance is associated with a declining market uncertainty.

A concurrent Ben Dor and Rosa (2019) study finds no pre-FOMC drift from April 2011 to December 2017 similarly to BGM. Our analysis differs in two ways. Following BGM, we distinguish between announcements with and without press conferences (in contrast to combining all announcements as in Ben Dor and Rosa (2019)) and we use a pre-FOMC window starting at the stock market open of the previous day (in contrast to a 24-hour pre-FOMC window in Ben Dor and Rosa (2019)). This allows us to show that the behavior of the pre-FOMC returns has changed: the drift initially remained in announcements with press conferences even after the end of the LM period, but it has weakened since January 2016 whereas Ben Dor and Rosa (2019) do not find any change in the pre-FOMC drift after 2015. It also allows us to test the possible explanation of reduced uncertainty.

Our data and method follow LM and BGM. There are 131 scheduled FOMC meetings from conferences, respectively. The first press conference took place in April 2011. The following press conferences took place in June and November 2011, January, April, June, September 3 LM discuss and reject several other explanations for the positive pre-FOMC drift: risk, good news, information leakage, volatility, and liquidity. LM point to rational inattention or behavioral biases as possible explanations. Several papers have explored alternative explanations such as differences of opinion (Cocoma, 2017) and constrained institutional buying pressure (Kaul & Watanabe, 2015) . Related Cieslak, Morse, and Vissing-Jorgensen (2019) find that the equity premium is earned entirely in weeks 0, 2, 4, and 6 of the FOMC cycle. We use intraday E-mini S&P 500 nearby contract futures prices. 6 Because this data begins only on September 10, 1997, we use the S&P 500 futures from September 1994 to September 9, 1997. Denoting price at time t by P t , we compute the log return, R t = ln(P t /P t−1 ). Following LM, we initially focus on the return in 24 hours ending 15 minutes before the announcement. For example, for 2:15 announcements, the return is computed from 2:00 pm on the day preceding the announcement day to 2:00 pm on the announcement day. The returns on non-announcement days are computed in the same 2:00 pm-to-2:00 pm window during the period from September 1994 to March 2011 and in the 1:45 pm-to-1:45 pm window during the period from April 2011 to December 2019. 7 Table 1 where the pre-FOMC mean return is positive and much higher than on non-announcement days. 8 This suggests that the pre-FOMC drift has recently weakened.

[ Table 1 about here.] Focusing on announcement days, we compute average cumulative returns over a threeday window around the FOMC announcements (from the day before the announcement to the day after the announcement). The top panel of Figure In addition, there appears to be an increase in the pre-FOMC drift before the ZLB liftoff that took place in December 2015, which coincides with a period of elevated uncertainty measured by the VIX implied volatility index. 10 The figure also shows that the returns before FOMC meetings with press conferences have become less volatile since the ZLB liftoff. This is consistent with reduced uncertainty during the period since the ZLB liftoff. during the LM period in Table 1 . In contrast, the mean pre-FOMC return in the second half of the sample (January 2016 to December 2019) is 0.092. We conduct a test to find out whether the central tendencies in the two halves of the sample are equal. We use the Wilcoxon rank-sum test and reject the null hypothesis of equal central tendency at 1% level.

This suggests that the pre-FOMC return distributions differ between the two periods. Table 2 ) is 0.054. To find out whether the central tendencies on days with announcements accompanied by press conferences and on non-announcement days are equal, we again use the Wilcoxon rank-sum test. We cannot reject the null hypothesis of equal central tendency at conventional significance levels. This suggests that stock returns do not tend to be higher before FOMC announcements that have press conferences relative to days that do not have FOMC announcements. Together, these two tests suggest that the pre-FOMC drift has weakened for announcements with press conferences since January 2016.

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McLean and Pontiff (2016) show evidence of return predictability disappearing after the predictability was discovered by academic researchers. This mechanism does not seem to be driving our result because it does not not explain why after the end of the LM sample period there initially was a preannouncement drift before FOMC announcements with press conferences. In this section, we therefore consider an alternative explanation for the disappearing drift: reduced uncertainty.

We proceed in two steps. In the first step, we analyze whether the drift before the FOMC meetings with press conferences differs between the period before the ZLB liftoff and the period after the ZLB liftoff. We estimate an ordinary least squares (OLS) event-study regression for announcements with press conferences from April 2011 to December 2019 where we regress the pre-FOMC returns (measured as in Table 2 ) on an indicator variable equal to one after the ZLB liftoff:

The first specification in Table 3 shows the results. The post-ZLB indicator variable is negative and statistically significant at 5% level. In addition, the sum of β 0 and β 1 (not reported in Table 3 ), which measures the mean pre-FOMC drift after the ZLB liftoff, is not statistically significant. This indicates that for meetings accompanied by press conferences the pre-FOMC drift in the period before the ZLB liftoff differs from the pre-FOMC drift in the period after the ZLB liftoff; in particular, the drift is lower after the ZLB liftoff than before the ZLB liftoff. 11

[ Table 3 about here.]

In the second step, we investigate whether uncertainty might have played a role in this change in the pre-FOMC drift. Following Gu et al. (2018) , we use the VIX implied volatility index as a measure of uncertainty about market conditions. We note that the average VIX is 17.7 and 14.7 before and after the ZLB liftoff, respectively, and this difference is significant 11 An alternative specification involves an event-study regression for announcements both with and without press conferences from April 2011 to December 2019 that regresses the pre-FOMC return on the press conference indicator variable and on the interaction term that interacts the press conference indicator variable with the ZLB liftoff indicator variable. The coefficient on the press conference indicator variable is 0.497 and statistically significant at 5% level. The coefficient on the interaction term is -0.353 also statistically significant at 5% level. Consistent with the first column of Table 3 , these results indicate that the pre-FOMC drift that existed before meetings accompanied by press conferences declined after the ZLB liftoff. at 1% level. To focus on pre-FOMC market uncertainty, we use VIX at market close two days before the FOMC announcements. We estimate the following equation:

The second specification in Table 3 

As a robustness check, we utilize an alternative measure of uncertainty following Gu et al. (2018) : the 10-year U.S. Treasury Note Volatility Index (TYVIX), a market-based measure of monetary policy uncertainty. Consistent with the analysis in Section 3.1 that uses VIX, we note that the average TYVIX is 5.90 and 4.68 before and after the ZLB liftoff, respectively, and this difference is significant at 1% level. To again focus on pre-FOMC market uncertainty, we use the TYVIX at market close two days before the FOMC announcements. We estimate equation (2) with TYVIX instead of VIX.

The third specification in Table 3 shows the results. As in the second column, the post-

This again indicates that the decrease in the pre-FOMC drift is associated with a reduction in uncertainty. In other words, the significance of the post-ZLB indicator variable in the first column is driven by the uncertainty differing between the before-ZLB and after-ZLB periods.

As an additional specification, we estimate equation (2) 

In addition to examining the impact of uncertainty by estimating equation (2), we analyze changes in VIX on announcement days with press conferences. We find evidence that FOMC announcements with press conferences were accompanied by greater uncertainty resolution before the ZLB liftoff than after the ZLB liftoff. Before the ZLB liftoff, the mean log-change in the VIX on days of these announcements is -6.52%, significant at 1% level. In contrast, after the ZLB liftoff, the mean log-change is an insignificant -1.27%. The difference between these log-changes is statistically significant at 5% level. This suggests that announcements with press conferences were accompanied by greater uncertainty resolution before the ZLB liftoff. In contrast, changes in the VIX on announcement days without press conferences are not significant before or after the ZLB liftoff during the post-LM period. These results are consistent with the results from estimating equation (2) in Section 3.2 showing that the lower pre-FOMC drift in recent years is explained by lower uncertainty.

We show that the pre-FOMC drift of Lucca and Moench (2015) has not only disappeared for announcements without press conferences as documented by Boguth et al. (2019) but also weakened in announcements with press conferences. This result is consistent with the explanation of reduced uncertainty. One interesting question for future research is whether the market uncertainty heightened by the COVID-19 pandemic in 2020 will bring an impact on the pre-FOMC returns, especially since the FOMC has been highlighting the health crisis and its consequences for economic activity as the reason for its monetary policy actions (Federal Reserve Bank, 2020). This table presents summary statistics for the log return computed as R t = ln(P t /P t−1 ), where P t denotes price at time t. The table uses data from April 2011 when the press conferences started to December 2019. The E-mini S&P 500 futures are used. The returns are reported for days with announcements accompanied by press conferences (PC), days with announcements unaccompanied by PC, and days without announcements. For announcement days, the return is computed from the stock market open on the day before the announcement to 15 minutes before the announcement. For non-announcement days, the return is computed from the stock market open on the previous day to 1:45 pm on the given day. Standard errors for the mean are in parentheses. The sample contains 40 FOMC announcements accompanied by press conferences. The sample period is from April 2011 when the press conferences started to December 2019. The first specification shows results of estimating Ret t = β 0 + β 1 P ostZLB t + t where Ret t is the pre-FOMC return measured as in Table 2 , and P ostZLB t is an indicator variable equal to one after the ZLB liftoff. The second specification includes V IX t measured as the level of the VIX index at the market close two days before the FOMC announcement (standardized to have a mean of zero and a standard deviation of one) following LM. The third specification includes T Y V IX t measured as the level of the TYVIX index at the market close two days before the FOMC announcement (standardized to have a mean of zero and a standard deviation of one). The fourth specification includes both VIX and TYVIX. Heteroskedasticity consistent standard errors are shown in parentheses. ** and *** indicate statistical significance at the 5% and 1% levels, respectively.

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Returns and rate

S&P 500 returns (8-meeting moving average) Pre-FOMC S&P 500 returns Effective federal funds rate

This figure shows the E-mini S&P 500 futures log returns from the stock market open on the day before the announcement to 15 minutes before the announcement (dashed black line), their 8-observation moving average (solid black line), and the effective federal funds rate (dotted red line). Only FOMC announcements with press conferences are included. The sample period is from