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Central bank signals, behavioral biases, and information flow

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  • Ardakani, Omid M.

Abstract

How central bank communications reshape market uncertainty is a fundamental question for monetary policy, yet existing tools, such as volatility proxies, event studies, and structural models, do not quantify directional information flow or account for behavioral distortions. This paper develops an information-theoretic framework to measure aggregate uncertainty using market entropy and to quantify directional information flows among assets using simulated and market data around Federal Reserve announcements. Results show that behavioral biases amplify short-term reactions to central bank signals, but these distortions fade as markets converge toward efficiency. Anticipated announcements reduce uncertainty, while unanticipated ones increase it, and such communications alter cross-asset dependence, weakening safe haven equity comovement while strengthening within-sector dependence. These findings reveal an information-transmission channel through which monetary policy signals reshape market dynamics beyond standard rational expectations benchmarks.

Suggested Citation

  • Ardakani, Omid M., 2026. "Central bank signals, behavioral biases, and information flow," Economic Modelling, Elsevier, vol. 158(C).
  • Handle: RePEc:eee:ecmode:v:158:y:2026:i:c:s0264999326000799
    DOI: 10.1016/j.econmod.2026.107550
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    JEL classification:

    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets

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