Risk Preferences and the Macroeconomic Announcement Premium

Abstract

This paper develops a revealed preference theory for the equity premium around macroeconomic announcements. Stock returns realized around pre‐scheduled macroeconomic announcements, such as the employment report and the FOMC statements, account for 55% of the market equity premium. We provide a characterization theorem for the set of intertemporal preferences that generates a nonnegative announcement premium. Our theory establishes that the announcement premium identifies a significant deviation from time‐separable expected utility and provides asset‐market‐based evidence for a large class of non‐expected utility models. We also provide conditions under which asset prices may rise prior to some macroeconomic announcements and exhibit a pre‐announcement drift.

Implied volatility duration: A measure for the timing of uncertainty resolution

“…Intuitively, investors with time-additive expected utility do not claim an announcement premium, since they only price covariation with current consumption, not the arrival of news about future consumption. In contrast to this, Ai and Bansal (2018) find that only 30 days with important announcements per year account for more than half of the total equity premium. They argue that such premiums can only arise in the presence of so-called risk-sensitive preferences such as those suggested by Epstein and Zin (1989).…”

“…Importantly, our approach is to compare stocks which differ with respect to the amount of uncertainty that 6 is resolved at different points in time. Our economic interpretation of our findings is based precisely on the rationale put forward by Ai and Bansal (2018).…”

Shaping Expectations and Coordinating Attention: The Unintended Consequences of FOMC Press Conferences

“…Kuttner (2001), Bernanke and Kuttner (2005), Ozdagli and Weber (2017), and Bjornland and Leitemo (2009) focus their analysis on FOMC announcements. More broadly, Savor and Wilson (2013), Lucca and Moench (2015), and Ai and Bansal (2018) show that investors demand large risk premia around FOMC announcements.…”

“…The separation of FOMC announcements due to PCs is also important to understand the equity risk premium. Recent empirical research documents large equity returns on FOMC announcement days (see, e.g., Savor and Wilson (2013), Lucca and Moench (2015)), which has been theoretically linked to large uncertainty (see Ai and Bansal (2018)) and heightened attention (see Andrei and Hasler (2014)). Correspondingly, we show that the pre-FOMC drift documented by Lucca and Moench (2015) exists only on PC days.…”

Asset Pricing with Endogenously Uninsurable Tail Risk

“…Ai and Bansal (2018) define the class of preferences under which marginal utility decreases with continuation utility as generalized risk-sensitive preferences. Generalized risk sensitivity is the key property of preferences captured by the assumption γ > 1 ψ that is responsible for the procyclical consumption share in our model.…”