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First a scream of fear. Even by the standards of economics, this summary is world-class word salad.
The paper examines the evidence on the macroeconomic announcement premium and its implications for equilibrium asset pricing models. Empirically, a large portion of the stock market risk premium is realized on a few trading days with significant macroeconomic announcements. We review the literature showing that the existence of the macroeconomic announcement premium implies that investors’ preferences must satisfy general risk sensitivity. We show how this conclusion generalizes to environments with heterogeneous investors and show how incorporating general risk sensitivity impacts economic analysis in dynamic environments with uncertainty.
That’s a shame, because the actual findings are fascinating. Since 1961, the approximately 44 days per year when there is important economic news have accounted for over 71 percent of total stock market returns.
And during this period, the even smaller Fed days are a particularly strong return booster, as you can see in this table (zoomable version):
This isn’t entirely new – Pavel Savor and Mungo Wilson first showed a decade ago that employment, inflation and interest rate news account for a surprising portion of stock market returns. Since then, many other economists have expanded on this by, for example, focusing on elections and the Fed in particular.
But in this article, Hengjie Ai, Ravi Bansal, and Hongye Guo look at the entire historiography of the field and show that the impact is indeed growing greater rather than contracting, which is what one would normally observe when the market encounters a strange, potentially profitable anomaly.
Specifically, the average announcement premium from January 2020 to August 2023 was 16.33 basis points per announcement, higher than the overall sample average of 10.68 basis points.
Given the wild macroeconomic shenanigans we’ve been dealing with since the start of 2020, that makes perfect sense. For example, inflation numbers almost didn’t matter for a decade, and now they really do Really Do. This is why macro hedge funds have generally had more fun in the last few years than in the previous decade.
Ai, Bansal, and Guo, of course, assume that economic news that dominates stock market returns likely reflects “risk compensation.” Economic uncertainty is bad, clarity is good, so investors who are willing to take a lot of risky positions before an announcement need to be compensated.
Whatever the cause, the increasing size is fascinating. Alphaville suspects it’s only a matter of time before someone launches the $FOMC, an ETF that simply goes long stocks three times before each major U.S. economic news release and shorts them on market-neutral days.