Premium for Heightened Uncertainty: Explaining Pre-Announcement Market Returns

Grace Xing Hu, Jun Pan, Jiang Wang, Haoxiang Zhu

NBER Working Paper No. 25817
Issued in May 2019, Revised in March 2020
NBER Program(s):Asset Pricing

We show that the pattern of positive pre-announcement market drift is present not only for FOMC announcements, as documented by Lucca and Moench (2015), but also for other major macroeconomic announcements such as Nonfarm Payroll, ISM and GDP. This commonality in pre-announcement returns leads us to hypothesize that there are two kinds of risks associated with pre-scheduled macroeconomic announcements. The first risk arises from the uncertain content of the news itself and is directional in nature, while the second risk is associated with the “heightened uncertainty” in anticipation of a pre-scheduled announcement, relating in particular to its potential market impact. Theoretically, we show that it is the resolution of this second risk prior to an announcement that leads to the positive pre-announcement drift. Moreover, our model shows that this second risk can be captured by VIX and the positive pre-announcement drift occurs in the absence of increases in conventional risk measures. We further provide direct evidence on the heightened uncertainty and its later resolution prior to the macroeconomic releases including FOMC. In addition to the pre-scheduled announcements, heightened uncertainty can also be triggered unexpectedly. Indeed, we find abnormally large returns on days following large spike-ups in VIX, with magnitudes comparable to the pre-announcement returns.

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Document Object Identifier (DOI): 10.3386/w25817

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