Finance Seminar（2019-07)

Topic: Premium for Heightened Uncertainty: Solving the FOMC Puzzle

Speaker: Grace Xing Hu, University of Hong Kong

Time: Wednesday, 20 February, 10:00-11:30

Location: Room 217, Guanghua Building 2

Abstract:

Lucca and Moench (2015) document 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. We hypothesis 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: First, we should see similar return patterns for other pre-scheduled macroeconomic announcements. Second, to the extent that we can find other proxies for heightened uncertainty, we should also observe abnormal returns accompanying its dissolution. Indeed, we find 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, we find disproportionally large returns on days following large spike-ups in VIX. Akin to the FOMC result, we find that while such heightened-uncertainty days occur on average only eight times per year, they account for more than 30% of the average annual return on the S&P 500 index. Conversely, we find a gradual but significant build-up in VIX prior to FOMC days, providing direct evidence of heightened uncertainty.

Introduction:

Dr. Grace Xing HU received her Ph.D. in Economics from Princeton University, and joined The University of Hong Kong as Assistant Professor of Finance in 2011. She also holds a B.S. in Computer Science from the University of Science and Technology of China, and a M.S. from Northwestern University. Grace’s research focus is on empirical asset pricing, in particular, liquidity, credit risk and financial crises. She has published in leading academic journals such as Journal of Finance, Journal of Financial Economics, International Review of Finance, among others.

//www.sef.hku.hk/~gracexhu.

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