Essays in Financial Economics

Baglioni, Tommaso

Essays in Financial Economics

Autores

Baglioni, Tommaso

Orientador

RUY MONTEIRO RIBEIRO

Tipo de documento

Tese

Data

2023

Arquivos

Tommaso Baglioni_Trabalho.pdf (3.17 MB)

Resumo

This dissertation studies topics in financial economics and contributes to the literature on equity return dynamics around scheduled Federal Open Market Committee (FOMC) announcements by highlighting new facts and presenting stronger empirical results than many articles in the international literature. This thesis is composed by three closely related papers, which are reported in this essay as chapters. These articles use U.S. intraday data and could be extended to other contexts, in accordance to data availability. The main variables of interest, which are constructed using intraday data on E-Mini S&P 500 futures at one-minute frequency, are the pre- FOMC announcement return and the post-FOMC announcement return, i.e., the 24-hour return in advance of the FOMC announcement and the return from the minute of the announcement until the end of the trading day, respectively. All articles relate to the anticipation and reaction of the stock market to monetary policy announcements and contribute empirically to a better understanding of the behavior of the stock market around monetary policy decisions. In particular, the three papers add to the empirical understanding of the facts described by Lucca and Moench (2015), who document a large average excess returns in U.S. equities before scheduled FOMC announcements, a phenomenon that they term “pre-FOMC announcement drift.” They show that half of the excess return in U.S. equities over the period 1980 – 2011 accrues in the 24 hours before scheduled FOMC announcements, whereas the average post-announcement return is approximately zero. They conclude that this unconditional excess return is not directly related to the actual FOMC monetary policy decision, highlighting a puzzle that is difficult to explain with standard asset pricing theory. Following Lucca and Moench (2015), a vast literature that explores the impact of FOMC announcements on financial markets began studying the pre-FOMC announcement drift and other related patterns around monetary policy announcements. In contrast with the previous literature, which focuses mainly on the pre-FOMC announcement drift and on the daily stock market return of the FOMC announcement day, this thesis focuses on the time series variation in both pre- and post-announcement return and highlights new interesting patterns related to the post-announcement return as well. In fact, only a handful of papers document patterns related to the stock market behaviour from the monetary policy announcement (or just before) until the end of the trading day. While those few papers focus on the immediate reaction of the stock market to the announcement, conditioned thus on the type of monetary policy news, the first two chapters of this thesis focus on the predictability of the post-announcement return (given the information publicly available before the announcement). The focus of the third article is on the predictability of the pre-announcement return. The first chapter, a joint work with Ruy Monteiro Ribeiro, is entitled “The FOMC Announcement Reversal.” This paper shows that part of the stock market reaction after the FOMC announcement is predictable, as the market tends to overreact in advance of the announcement and to correct afterward. In particular, there is a negative relationship between pre-FOMC announcement returns and post-FOMC announcement returns, independent of the level of uncertainty and sample period. To exploit this finding, this paper proposes and tests a reversal strategy consisting in buying (selling) E-Mini S&P 500 just before the announcement, if the pre-FOMC announcement return is negative (positive), and closing the position at the end of the trading day. Over the period 1997 – 2020, considering 180 scheduled FOMC announcements, this strategy generates Sharpe ratios about 2.5 times greater than the pre-FOMC announcement drift puzzle of Lucca and Moench. The second chapter, entitled “Liquidity Premium Around FOMC Announcements,” is a joint work with Alessandro Giannozzi, Ruy Monteiro Ribeiro, and Oliviero Roggi. This paper explores the relationship between stock market liquidity and stock market return around scheduled FOMC meetings and highlights the importance of liquidity in the predictability of returns that follow the monetary policy decision. This article shows that the classic liquidity measure proposed by Amihud (2002) is empirically relevant to predict the stock market behavior, despite the fact that we are analyzing the most liquid market in the world. The main finding is that the post-FOMC announcement interval is characterized by a conditional liquidity premium, suggesting that market liquidity is an important determinant of the FOMC premium. In contrast, the unconditional liquidity premium is not statistically significant. The third chapter, which is a joint work with Ruy Monteiro Ribeiro, is entitled “Corporate Bonds Distress and FOMC Announcement Returns.” This paper documents that the ex-ante level of the corporate bond market distress is a good predictor for the pre-FOMC announcement equity market return, which tends to be positive (negative) when distress on the week before the announcement is high (low). Distress subsumes the relevant information of equity market uncertainty, highlighted by the previous literature as a good predictor for the pre-FOMC announcement return. This article also shows that, on FOMC announcement days, the effect of distress is heterogeneous across industries, as it is much more pronounced on the return of the industries that are more sensitive to credit, suggesting that distress is part of the credit channel of monetary policy transmission.