Stocks & Bonds
One Good Paper: A Stock Market Puzzle
By Brendan Greeley on March 22, 2013
The Federal Open Market Committee is as close as America gets to a table of philosopher kings. Eight times a year, the Board of Governors of the Federal Reserve and the five voting chairs of the regional Federal Reserve banks sit in a closed room and make a decision—whether to change monetary policy. Since 1994, the committee has announced its decision at 2:15 on the afternoon of the day it meets. You might expect the FOMC’s announcement to move markets. It does. But since last year, we’ve known that markets move not after the 2:15 p.m. announcement but in the 24 hours before it. Since 1994, the value of the S&P 500 index has increased, on average, 49 basis points the day before the FOMC announcement, an order of magnitude more than on any other day. Again: before. After the announcement, returns average out to zero.
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The timing of stock gains around the FOMC announcement is such an observation. Uhlig recommends the 2012 Federal Reserve Bank of New York staff report that documents it: The Pre-FOMC Announcement Drift.
The paper’s observation sits atop what is already a long-standing dispute among economists: Why do stocks earn higher returns than bonds? The academics trying to answer that question have at least by now divided themselves into camps. Robert Barro, for example, believes that every couple of decades something disastrous happens to equities, and that this low-probability, high-severity risk underlies all the smaller events that bounce stock prices around and explains why, over time, stocks command a higher return. (Economists call this higher return the “equity premium.”) Now, the New York Fed staff report has determined that what it calls a “staggering 80 percent” of the equity premium since 1994 was earned, yes, in the day before the FOMC announcement. No similar effect was observed for bonds.
.... One Good Paper: A Stock Market Puzzle - Businessweek
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