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The Pre-FOMC Announcement Drift and Private Information: Kyle Meets Macro-Finance

Chao Ying

2020 Papers from Job Market Papers

Abstract: This paper proposes and tests the private information explanation for the time series of pre-FOMC announcement drift. I document the informed trading is in the same direction of the realized returns in the 24-hour window before FOMC announcements, coinciding with the pre-FOMC uncertainty reduction. I integrate Kyle's (1985) model into a standard consumption-based asset pricing framework where the market makers are compensated for the risk of assets' fundamentals. Observing aggregate order flow, they update the belief about the marginal utility-weighted asset value, which resolves uncertainty gradually and results in an upward drift in market prices before announcements. I demonstrate that there is a strictly positive pre-FOMC drift if and only if the market makers require risk compensation.

JEL-codes: E44 G12 G14 (search for similar items in EconPapers)
Date: 2020-08-22
New Economics Papers: this item is included in nep-mac and nep-ore
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