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Recovering the FOMC risk premium

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  • Liu, Hong
  • Tang, Xiaoxiao
  • Zhou, Guofu

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.

Suggested Citation

  • Liu, Hong & Tang, Xiaoxiao & Zhou, Guofu, 2022. "Recovering the FOMC risk premium," Journal of Financial Economics, Elsevier, vol. 145(1), pages 45-68.
    • Handle: RePEc:eee:jfinec:v:145:y:2022:i:1:p:45-68
    DOI: 10.1016/j.jfineco.2022.04.005
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    Cited by:

    1. Juan M. Londono & Mehrdad Samadi, 2023. "The Price of Macroeconomic Uncertainty: Evidence from Daily Options," International Finance Discussion Papers 1376, Board of Governors of the Federal Reserve System (U.S.).

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    More about this item

    Keywords

    Options; FOMC meeting; Risk premium; Drift; Recovery;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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