How Much Do Investors Care about Macroeconomic Riskpresenter: Eddie Aronovich, Tel-Aviv University,...

IntroductionThis study contribution

Summary of ResultsSummary

How Much Do Investors Care aboutMacroeconomic Risk ?

Evidence From Scheduled Economic Announcements

Pavel Savor1 Mungo Wilson2

1The Wharton School, University of Pennsylvania

2Said Business School, Oxford University

Utah Winter Finance Conference, 2010

presenter: Eddie Aronovich, Tel-Aviv University, Advanced Finance course



Outline

1 IntroductionSchrodinger’s CatIntuition and Motivation

2 This study contributionOur modelPrevious workInformation processedSimilar results

3 Summary of Results

4 Summary




Schrodinger’s CatIntuition and Motivation

The elevator talk for this research

How does macroeconomic indicators affects asset pricesand their risk ?

Methodology: Analyze the prescheduled macroeconomicsnews announcements affects on stocks and T-bills prices





Outline




4 Summary





The same poor cat

The challenge of statistical inference and more...

Luckily the macroeconomics does not assumes S/P (yet!)





Outline




4 Summary





Intuition

Announcements days clears the macroeconomic state⇒The days before should reflect expectations and theday(s) after the information

The risk on announcement days includes inter-temporalrisk in addition to market risk - Merton (1973)





Basic assumptions

Market behavior is affected by macroeconomic information

Most of the information arrives randomly (nonscheduledevents)Some (important) information is prescheduled announced(content is unknown)

Bearing this risk can be pricedThe expectation can be measured neutrallyThe research was made based US data onlyAnd all the other regular assumptions...





Main findings (1/2)

Stocks excess returnExcess return on announcements days : 10.6 bps

Overall excess market return: 1.0 bps per day

60% of cumulative annual excess return is earned in 13%of the trading days

30-days T-billsT-bills announcement day return: 1.5 bps

Overall excess market return: 1.7 bps





Main findings (2/2)

VolatilityStock market return volatility moderately higher onannouncement days (5%-8%)T-bills volatility is small (and smaller on announcementdays)




Our modelPrevious workInformation processedSimilar results

Outline




4 Summary





Focus on the expected asset value

rt+1 = Et [rt+1] + βzt+1 + εt+1

Et [rt+1]- Expected asset value as predicted at time tβ- Response coefficientzt+1- Distance between expectation and realizationεt+1- Volatility of shocks





We analyzed different components

Focus on returns (Et [tt+1]) rather than on β′sAnalyzing the average realized return rather thanannouncement surprise zt+1

Estimate the magnitude of difference of expected returnson prescheduled announcements days vs. other days





Outline




4 Summary





Mainly focus on estimating β

Responsiveness of βResponsiveness of β to macro surprises zt+1- Schwert(1981), ...,Fleming and Remolona (1997)

Sensitivity of security returns to unemployment surprisesSensitivity of security returns to unemployment surprises -Boyd, Hu and Jagannathan (2005)Stock market response to rising unemployment:

Positive - during economic expansions (positive β)Negative- during constrains





Additional previous works

Direct and Indirect announcements effectDirect announcements effect expressed by β and indirectby εt+1 - Flannery and Protopapadakis (2002)

Only monetary aggregate relation affects directly andindirectly (out of 17 candidates).

Treasury bonds excess on announcement days - Jones,Lamont and Lumsdaine (1998)

Analyzed long term Treasury bonds excess on PPI andemployment announcements days.

Excess return and volatility is higher on these days.We use similar methodology





Previous Work on Analytics

Conditional variance - Bansal and Yaron (2005)Volatility and risk estimation - Bansal, Khatacharian andYaron (2004)





Outline




4 Summary





Macro indicators scheduled publication

Consumer Price Indexes (CPI) - program producesmonthly data on changes in the prices paid by urbanconsumers for a representative basket of goods andservices - once a monthProducer Price Index (PPI) program measures theaverage change over time in the selling prices received bydomestic producers for their output - once a monthEmployment figures - once a monthFederal Open Market Committee (FOMC) - controls thethree tools of monetary policy–open market operations, thediscount rate, and reserve requirements (The FederalReserve Act of 1913 gave the Federal Reserveresponsibility for setting monetary policy). - 8 scheduledmeeting per year





The stock data

Bureau if Labor Statistics (1958-2008)609 employment announcements

Federal Reserve (1978-2008)269 scheduled announcements

CPI (1958-1971), PPI (Feb 1971-Dec 2008)157 pre-scheduled CPI announcements454 pre-scheduled PPI announcementsPPI announcements released a few days earlierdiminishes CPI





The treasury bill (T-bill) data

CRSP Jun 1961-Dec 2008Daily return on T-bill closest to 30 daysAssumption: log returns on Mondays X3 higher since itcomes after (3) days (Fri-(Sat-Sun)-Mon)Longer return calculated separately in same manner

CBOE S&P 100 Vix index (1986-2008)30-days implied volatility





Interesting information about the data

Total1415-announcements days11424-non (pre-scheduled) announcements days51 days - multiple announcements23 days - non-trading

Distribution of the announcements days>50% Occurs on Fridays<2% of the announcements are are published on Mondays





Risk estimation

Investor assumed to have recursive Epstein-Zin preference

Ut =

(1− β) C1− 1

ψ

t + β(

Et

[U1−γ

t+1

]) 1− 1ψ

1−γ

1

1− 1ψ

β - time discount rateγ - coefficient of relative risk aversionψ - elasticity of inter-temporal substitutionMarket clearing assumes investor consumes the aggregateendowment (Ct = Dt )





Model with time-varying drift

dt = loge (Dt )

Following AR(1) process

µt+1 = (1− φ)µ̄+ φµt + νµ,t+1

From Bansal and Yaron (2004)

Conditional variances (assuming higher on announce. days)

Vart[νx ,t+1

]= σ2

x ,L +(σ2

x ,H − σ2x ,L

)At+1

At+1 =

{1 announcement day between t , t+10 o.w





Outline




4 Summary





Similar results in related researches

Earnings announcement premium - Beaver (1968)

Increased risk could not explain the above-average returnaround earnings

Above average return for dividend announcements - Kalayand Lowenstein (1985)




Table-1: Summary Statistics for Daily Stock MarketExcess Return




Table-2: Regression analysis Daily Stock MarketExcess Return




Figure-1 Daily Treasury Bonds excess onannouncements and non-announcements days




Table-3 Summary Statistics for 30-day T-bill Returns




Table-4 Regression Analysis Daily 30-day T-billReturns




main findings

Stock excess return is higher on announcements daysT-bills excess return is lower on announcement daysThe risk premia is higher on announcement days




Thank you !


How Much Do Investors Care about Macroeconomic Riskpresenter: Eddie Aronovich, Tel-Aviv University,...

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