Recovering the FOMC risk premium

Hong Liu; Xiaoxiao Tang; Guofu Zhou

doi:10.1016/j.jfineco.2022.04.005

Recovering the FOMC risk premium

Hong Liu
, Xiaoxiao Tang
, Guofu Zhou

Research output: Contribution to journal › Article › peer-review

13 Scopus citations

Abstract

The Federal Open Market Committee (FOMC) meetings are among the most important economic events. We propose a novel method to recover the FOMC risk premium and drift sizes. Empirically, we find that for the 192 meetings from 1996 to 2019, the FOMC risk premium varies across meetings, from 1 to 326 basis points (bps) with an average of 45 bps. We obtain an out-of-sample R² of 7.51% when using the recovered FOMC premium to predict the meeting returns around the announcement. The average predicted upward drift size is 101 bps, and the average predicted downward drift size is 129 bps, matching well with the realized ones.

Original language	English
Pages (from-to)	45-68
Number of pages	24
Journal	Journal of Financial Economics
Volume	145
Issue number	1
DOIs	https://doi.org/10.1016/j.jfineco.2022.04.005
State	Published - Jul 2022

Keywords

Drift
FOMC meeting
Options
Recovery
Risk premium

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10.1016/j.jfineco.2022.04.005

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title = "Recovering the FOMC risk premium",

abstract = "The Federal Open Market Committee (FOMC) meetings are among the most important economic events. We propose a novel method to recover the FOMC risk premium and drift sizes. Empirically, we find that for the 192 meetings from 1996 to 2019, the FOMC risk premium varies across meetings, from 1 to 326 basis points (bps) with an average of 45 bps. We obtain an out-of-sample R2 of 7.51\% when using the recovered FOMC premium to predict the meeting returns around the announcement. The average predicted upward drift size is 101 bps, and the average predicted downward drift size is 129 bps, matching well with the realized ones.",

keywords = "Drift, FOMC meeting, Options, Recovery, Risk premium",

author = "Hong Liu and Xiaoxiao Tang and Guofu Zhou",

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AU - Liu, Hong

AU - Tang, Xiaoxiao

AU - Zhou, Guofu

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N2 - The Federal Open Market Committee (FOMC) meetings are among the most important economic events. We propose a novel method to recover the FOMC risk premium and drift sizes. Empirically, we find that for the 192 meetings from 1996 to 2019, the FOMC risk premium varies across meetings, from 1 to 326 basis points (bps) with an average of 45 bps. We obtain an out-of-sample R2 of 7.51% when using the recovered FOMC premium to predict the meeting returns around the announcement. The average predicted upward drift size is 101 bps, and the average predicted downward drift size is 129 bps, matching well with the realized ones.

AB - The Federal Open Market Committee (FOMC) meetings are among the most important economic events. We propose a novel method to recover the FOMC risk premium and drift sizes. Empirically, we find that for the 192 meetings from 1996 to 2019, the FOMC risk premium varies across meetings, from 1 to 326 basis points (bps) with an average of 45 bps. We obtain an out-of-sample R2 of 7.51% when using the recovered FOMC premium to predict the meeting returns around the announcement. The average predicted upward drift size is 101 bps, and the average predicted downward drift size is 129 bps, matching well with the realized ones.

KW - Drift

KW - FOMC meeting

KW - Options

KW - Recovery

KW - Risk premium

UR - https://www.scopus.com/pages/publications/85129236788

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DO - 10.1016/j.jfineco.2022.04.005

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VL - 145

SP - 45

EP - 68

JO - Journal of Financial Economics

JF - Journal of Financial Economics

IS - 1

ER -

Recovering the FOMC risk premium

Abstract

Keywords

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