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Walking on thin ice: Market quality around FOMC announcements
Economics Letters 138 (2016) 5–8
Contents lists available at ScienceDirect
Economics Letters journal homepage: www.elsevier.com/locate/ecolet
Walking on thin ice: Market quality around FOMC announcements Carlo Rosa Division of Monetary Affairs, Board of Governors of the Federal Reserve System, Washington, DC, 20551, United States
highlights • • • •
This paper analyzes market quality around Federal Reserve announcements. FOMC statements induce significantly ‘‘higher than normal’’ volatility and trading volume. The bid–ask spread increases significantly before the release of the statement. Market depth is lower on event days, hitting an intraday trough before the FOMC release.
article
info
Article history: Received 2 August 2015 Received in revised form 15 October 2015 Accepted 21 October 2015 Available online 29 October 2015 JEL classification: E52 G14
abstract This paper examines market quality for the E-Mini S&P 500 futures around Federal Reserve announcements. I document that the release of the Federal Open Market Committee (FOMC) statement induces significantly ‘‘higher than normal’’ volatility and trading volume. The bid–ask spread is significantly higher in the minutes preceding the release, but it returns to its ‘‘normal’’ level immediately after the release. Using order-level data, I show that market depth behind the best bid and ask quotes is much lower on event days, hitting an intraday low immediately before the FOMC release at values on average about 20 percent of the level observed in control days. © 2015 Elsevier B.V. All rights reserved.
Keywords: U.S. Federal Reserve Central bank announcements High-frequency data Market quality
1. Introduction The analysis of market quality is an important topic for several reasons. From an asset pricing perspective, the market microstructure nuances of how information is impounded into prices have important implications for formulating effective trading and hedging strategies and asset allocation decisions. From a financial stability perspective, understanding the dynamics of the market liquidity helps to prevent disruptive events, such as the 2010 ‘‘flash crash’’ (CFTC, 2010). Many studies have examined the response of US asset prices to Federal Reserve monetary policy announcements (see, e.g., Rigobon and Sack, 2004; Bernanke and Kuttner, 2005, and references therein). This paper extends the existing literature by examining the impact of monetary news on various measures of market liquidity, such as bid–ask spread, trading volume and depth of the order book.
E-mail address: [email protected]. URL: http://www.federalreserve.gov/econresdata/carlo-rosa.htm. http://dx.doi.org/10.1016/j.econlet.2015.10.029 0165-1765/© 2015 Elsevier B.V. All rights reserved.
This paper examines market liquidity and the dynamics of limit orders in the E-Mini S&P 500 futures market around Federal Reserve announcements using a novel high-frequency dataset for the period from 2008 to 2014. The main findings can be summarized as follows. First, I document that the release of the Federal Open Market Committee (FOMC) statement induces significantly ‘‘higherthan-normal’’ volatility and trading volume. The bid–ask spread is significantly higher in the minutes preceding the release, but it returns to its ‘‘normal’’ level shortly after the release. Second, using order-level data I precisely quantify the dynamics of the limit order book on announcement days. I show that market depth behind the best bid and ask quotes is much lower on event days, hitting an intraday low immediately before the FOMC release at values on average about 20% of the level observed in control days, and gradually recovering to its pre-announcement level. Taken together, these findings suggest that most of the adjustment ahead of monetary news happens through the size of order book entries, rather than through prices (bid–ask spread). The rest of the paper is organized as follows. Section 2 describes the dataset. Section 3 discusses the empirical results. Finally, Section 4 concludes.
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2. Data The high-frequency data on US stock prices consist of traded price and volume, as well as market depth data (bid and ask prices, and bid and ask quantities up to 10 levels) for the E-Mini S&P 500 (ES) futures security. The sample period is from August 2008 to December 2014, and is determined by data availability.1 All market depth data are time-stamped to the nearest millisecond. Tick data are converted into one-minute series using the previous-tick method, i.e., observations at the end of each one-minute interval are used to generate the series of (equally-spaced) one-minute prices. Trading volume corresponds to the sum of the number of contracts traded during a minute. The choice of one-minute sampling frequency provides a reasonable balance between sampling as finely as possible, and minimizing the impact of the market microstructure noise usually found in very high-frequency data (Bandi and Russell, 2008). At a given point in time, the Chicago Mercantile Exchange (CME) lists five quarterly contracts that can be actively traded. A continuous series is constructed by considering the front-month contract (e.g., the nearest unexpired futures contract in the contract sequence), and rolling over to the next contract on the expiration date. I use the ES security in this study because it is the most popular equity index futures contract in the world, and so it is particularly suitable for analyzing market microstructure issues. For instance, the CME Group noted in its 2015 report (CME Group, 2015) that the E-Mini S&P contract traded, on average, $162 billion in transaction dollar volume per day versus the $21 billion traded by the SPDR S&P 500 Trust (SPY) ETF. Moreover, the ES security can be traded nearly 24/7 during the weekdays on the CME Globex system. Finally, a number of studies (see, e.g., Shyy et al., 1996) document that price movements in the futures markets consistently lead the stock index movements. 3. Results As a preliminary illustration of the effects of Federal Reserve announcements on market quality, Fig. 1 shows the intraday dynamics of the quoted number of September 2013 ES futures contracts on the bid and ask side up to 5 and 10 price levels around the release of the June 2013 FOMC statement.2 The dashed line reports the total market depth for 10 levels on a non-event day. Market depth is lower compared with non-event days and declines sharply immediately before the FOMC release to about 20% of the level observed in control days. This example underscores the fact that the passage of a risk event, such as the FOMC announcement, has a large impact on the depth of the order book of a highly liquid asset. Having illustrated the effect of one FOMC statement on market depth, I now turn to a more systematic analysis of the dynamic behavior of various liquidity measures from 30 min before to one hour after the release of the monetary news. Panel A of Fig. 2 displays the volatility of one-minute stock returns on event days (solid blue line) and non-event days (dashed black line), defined
1 Data on market depth are available from July 3, 2008, for 5 levels, and from February 26, 2010, for 10 levels. The data used in this study are provided by the Chicago Mercantile Exchange via Thomson Reuters. The front-month ES futures contract is extremely liquid: on a random day (July 9th, 2014, which featured median daily volume for 2014), there were roughly 3 million changes in the top 10 levels of the order book. 2 A limit order book is the collection of all active limit orders (i.e., orders to buy a security at no more than a specific price, or to sell a security at no less than a specific price), arranged first by price and then by arrival time. The best (highest) bid and the best (lowest) ask are referred as the top of the book, and together with their associated quantities, they represent level one of the order book. Similarly, level k is the price–quantity pair associated with the kth highest bid and the kth lowest ask.
Fig. 1. Market quality around the June 2013 FOMC announcement. This figure shows the intraday market depth of the front-month of the E-Mini S&P 500 futures contract around the FOMC announcement of June 19, 2013. The blue and red areas represent the number of contracts available on the first five levels of the ask and bid sides of the order book, whereas the light blue and light red areas represent the number of contracts available on levels 6 through 10 of the ask and bid sides of the order book. The dashed black line represents the total number of contracts available on the first 10 levels on a control day (in this case, the previous day). The vertical line is placed at the release time of the FOMC statement (2:00 P.M., Eastern Standard Time). (For interpretation of the references to color in this figure legend, the reader is referred to the web version of this article.)
as the same hours of the day before and after the FOMC meeting day. Panel B displays the median ratio between volumes on event days and control days, and Panel C plots the ratio of the mean bid–ask spreads on event and non-event days.3 Large and small filled squares indicate that the volatility is significantly different in the two subgroups, or that the median ratio of volume and bid–ask spread is significantly different from one, at the 1% and 5% levels, respectively. The volatility of the ES futures one-minute returns suddenly jumps at the time of the release of the FOMC statement, becoming roughly five times larger than usual, and remaining significantly higher for the following hour (see also Rosa, 2013). Trading activity is lower than normal before the release of the FOMC statement, becomes seven times larger at the time of the release, and then gradually returns to its normal level. Finally, Panel C shows that the bid–ask spread is significantly higher in the minutes preceding the release, but it returns to its ‘‘normal’’ level immediately after the release. These results suggest that equity traders take a ‘‘wait-and-see’’ approach leading up to the release of the FOMC statement; they are also consistent with those reported in previous studies, such as Bomfim (2003), who notes that the stock market tends to be relatively quiet before scheduled FOMC policy announcements.4 Chung et al. (2013) also analyze various intraday liquidity measures around FOMC announcements. This paper complements their findings by documenting that the decrease in liquidity associated with policy announcements occurs both before and after FOMC announcements.5 The most novel aspect of the results, however, is the dynamics of limit orders around FOMC announcements. Panel A of Fig. 3
3 As a robustness check, I define as control days the same hours and weekdays of the previous and following week of the FOMC meeting day. Estimation results (available upon request) are very similar to those reported in the main text. 4 Jones et al. (1998) use daily data on Treasury securities for the sample 1979–1995, and document a ‘‘calm-before-the-storm’’ effect on days prior to important macroeconomic announcements. Fleming and Piazzesi (2005) use oneminute Treasury data for the sample 1994 to 2004, and document that bid–ask spreads rise ahead of the FOMC announcement, whereas yield volatility and volumes peak shortly after the announcement. This paper complements those findings by looking at various measures of liquidity conditions in the stock market around FOMC announcements, including the response of the depth of the order book, for a more recent sample (2008–2014). Most aspects of the adjustment process look similar to those reported for Treasury securities. 5 There are a number of differences between this work and Chung et al. (2013). First, this paper documents the dynamics of the order book not only at the best offer and bid quotes, but also behind the best quotes. Second, the sample used in this paper is from 2008 to 2014, rather than from 1995 to 2005. Finally, this paper uses one-minute frequency data, rather than 5-min and 30-min frequency data.
C. Rosa / Economics Letters 138 (2016) 5–8
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Fig. 3. Market quality around the releases. This figure displays the median ratio between market depth on event days and control days, defined as the same hours of the day before and after the FOMC meeting day. Market depth is the number of contracts available on the first five levels of the ask and bid sides of the limit order book. The sample period is August 2008 to December 2014. The interval spans from 30 min before to one hour after the event time. The vertical line is placed at the release time of the FOMC statement (Panel A) or nonfarm payrolls (Panel B). The Wilcoxon signed rank test is employed to test the null hypothesis that the median ratio of announcement days over control days equals one. Large and small filled squares denote significance of the differences at the two-sided 1% and 5% levels, respectively.
Fig. 2. Volatility, volume, and bid–ask spread around the release of the FOMC statement. This figure displays the volatility, trading volume and bid–ask spread around the release of the FOMC statement compared with control days, defined as the same hours of the day before and after the FOMC meeting day. Panel A plots (i) the standard deviation of one-minute stock returns (e.g., percentage changes) on event days with a solid blue line, and (ii) the standard deviation of one-minute stock returns on non-event days with a dashed black line. Panel B plots the median ratio between volumes on event days and control days. Panel C plots the ratio of the mean bid–ask spreads on event and non-event days. The sample period is August 2008 to December 2014. The interval spans from 30 min before to one hour after the event time. The vertical line is placed at the release time of the FOMC statement. For Panel A, the Brown and Forsythe’s (1974) statistic is employed to test the null hypothesis of equal variance in each subgroup. For Panel B, the Wilcoxon signed rank test is employed to test the null hypothesis that the median ratio of announcement days over control days equals one. For Panel C, the Wilcoxon–Mann–Whitney test (with tie correction) is employed to test the null hypothesis that the median on announcement days equals the median on control days. Large and small filled squares denote significance of the differences at the two-sided 1% and 5% levels, respectively.
displays the median ratio between market depth on FOMC meeting days and control days, where market depth represents the number of contracts available on the first five levels of the ask and bid sides of the order book.6 Large and small filled squares indicate that the
6 I examine the robustness of the baseline results along several dimensions: (1) I consider the size of the bid and ask entries of the order book separately; (2) I look at 10 levels of the order book, rather than 5 levels; and (3) I use as a testing security the front-month contract of the e-mini Nasdaq 100 futures, instead of the e-mini S&P 500 futures. Overall, the econometric results remain very similar to those presented in Fig. 3.
median ratio is significantly different from one, at the 1% and 5% levels, respectively. Market depth is much lower on event days, reaching its lowest point immediately before the FOMC release at values on average about 20% of the level observed in control days, and gradually recovering to its pre-announcement level. To investigate whether market quality around monetary news differs from the dynamics featured around macroeconomic releases, I look at the effect of nonfarm payrolls announcements, sometimes called the king of macroeconomic releases (Andersen and Bollerslev, 1998).7 The adjustment process induced by nonfarm payrolls resembles the adjustment to FOMC announcements. However, some aspects, such as the magnitude of the response, look somewhat different. For instance, the volume and the bid–ask spread at the time of nonfarm payrolls release are about 11 and 1.6 times higher than the levels on event days. Moreover, trading volume before the release of nonfarm payrolls is slightly higher on announcement days than on control days (see separate Appendix for further details). Panel B of Fig. 3 displays the median ratio of (total) market depth for five levels on announcement days and non-event days. In this case the market depth reaches a trough immediately before the macro release, at roughly 20% of the level observed in control days, and in about 10 min returns back to the level on nonevent days. One potential explanation of the difference in the post-
7 Erenburg and Lasser (2009) and Scholtus et al. (2014) also document that market quality, measured by spread and depth, deteriorates during macroeconomic releases.
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announcement reaction of nonfarm payrolls compared with FOMC announcements may be that the monetary news is released in the afternoon, so equity traders do not have much time before the end of the trading session to adjust their portfolio holdings. In contrast, nonfarm payrolls are released in the morning, giving traders the entire trading day to adjust their positions.8 4. Conclusion This paper tries to shed some light on the link between monetary announcements and market quality. I document that the release of the FOMC statement induces volatility and trading volume that are significantly ‘‘higher than normal’’, whereas the bid–ask spread is significantly higher immediately before the release of the statement. Using order-level data, I also show that market depth is much lower on event days: it dips appreciably immediately before the FOMC release to about 20% of the level observed in control days, and returns to its pre-announcement level 10 min after the release. Taken together, these results suggest that most of the adjustment ahead of monetary news happens through the size of the order book, rather than through prices (bid–ask spread). Acknowledgments I thank Michael Fleming, Yesol Huh, Tony Rodrigues, and Giovanni Verga for useful comments. I also thank an anonymous referee for detailed comments on an earlier draft of the paper that led to significant improvements. All remaining errors are mine. The views expressed herein are mine alone, and do not reflect the views of the Federal Reserve Board or its staff.
8 The impact of the FOMC minutes (released at 2 p.m., eastern time) on market depth is similar to that of the FOMC statement (results available upon request) and corroborates this explanation. The different response pattern may depend on a number of other aspects, including the direction of the surprise, the relative precision of traders’ prior beliefs, or the presence of potential informational leakages. Note also that the informational content of FOMC announcements differs from that of nonfarm payrolls. The FOMC statement contains not only an assessment of the economy, but also information about the Committee’s reaction function, and it comprises both qualitative (such as the interpretation of incoming data and economic conditions) and quantitative (e.g., target rate decisions and quantity of asset purchases) information.
Appendix A. Supplementary data Supplementary material related to this article can be found online at http://dx.doi.org/10.1016/j.econlet.2015.10.029. References Andersen, T.G., Bollerslev, T., 1998. Deutsche mark-dollar volatility: intraday activity patterns, macroeconomic announcements, and longer run dependencies. J. Finance 53 (1), 219–265. Bandi, F.M., Russell, J.R., 2008. Microstructure noise, realized variance, and optimal sampling. Rev. Econom. Stud. 75 (2), 339–369. Bernanke, B.S., Kuttner, K., 2005. What explains the stock market’s reaction to Federal Reserve policy? J. Finance 60 (3), 1221–1257. Bomfim, A.N., 2003. Pre-announcement effects, news effects, and volatility: Monetary policy and the stock market. J. Bank. Finance 27 (1), 133–151. Brown, M.B., Forsythe, A.B., 1974. Robust tests for the equality of variances. J. Amer. Statist. Assoc. 69 (346), 364–367. CFTC, 2010. Findings regarding the market events of May 6, 2010. Commodity Futures Trading Commission Staff Report. Chung, K.H., Elder, J., Kim, J.-C., 2013. Liquidity and information flow around monetary policy announcement. J. Money Credit Bank. 45 (5), 781–820. CME Group, 2015. The big picture: A cost comparison of futures and ETFs. Chicago Mercantile Exchange Working Paper. Erenburg, G., Lasser, D., 2009. Electronic limit order book and order submission choice around macroeconomic news. Rev. Financ. Econ. 18 (4), 172–182. Fleming, M.J., Piazzesi, M., 2005. Monetary policy tick-by-tick. Federal Reserve Bank of New York Working Paper. Jones, C., Lamont, O., Lumsdaine, R., 1998. Macroeconomic news and bond market volatility. J. Financ. Econ. 47 (3), 315–337. Rigobon, R., Sack, B., 2004. The impact of monetary policy on asset prices. J. Monetary Econ. 51 (8), 1553–1575. Rosa, C., 2013. The financial market effect of FOMC minutes. Fed. Reserve Bank N. Y. Econ. Policy Rev. 19 (2), 67–81. Scholtus, M., van Dijk, D., Frijns, B., 2014. Speed, algorithmic trading, and market quality around macroeconomic news announcements. J. Bank. Finance 38, 89–105. Shyy, G., Vijayraghavan, V., Scott-Quinn, B., 1996. A further investigation of the lead–lag relationship between the cash market and stock index futures market with the use of bid/ask quotes: The case of France. J. Futures Mark. 16 (4), 405–420.
Contents lists available at ScienceDirect
Economics Letters journal homepage: www.elsevier.com/locate/ecolet
Walking on thin ice: Market quality around FOMC announcements Carlo Rosa Division of Monetary Affairs, Board of Governors of the Federal Reserve System, Washington, DC, 20551, United States
highlights • • • •
This paper analyzes market quality around Federal Reserve announcements. FOMC statements induce significantly ‘‘higher than normal’’ volatility and trading volume. The bid–ask spread increases significantly before the release of the statement. Market depth is lower on event days, hitting an intraday trough before the FOMC release.
article
info
Article history: Received 2 August 2015 Received in revised form 15 October 2015 Accepted 21 October 2015 Available online 29 October 2015 JEL classification: E52 G14
abstract This paper examines market quality for the E-Mini S&P 500 futures around Federal Reserve announcements. I document that the release of the Federal Open Market Committee (FOMC) statement induces significantly ‘‘higher than normal’’ volatility and trading volume. The bid–ask spread is significantly higher in the minutes preceding the release, but it returns to its ‘‘normal’’ level immediately after the release. Using order-level data, I show that market depth behind the best bid and ask quotes is much lower on event days, hitting an intraday low immediately before the FOMC release at values on average about 20 percent of the level observed in control days. © 2015 Elsevier B.V. All rights reserved.
Keywords: U.S. Federal Reserve Central bank announcements High-frequency data Market quality
1. Introduction The analysis of market quality is an important topic for several reasons. From an asset pricing perspective, the market microstructure nuances of how information is impounded into prices have important implications for formulating effective trading and hedging strategies and asset allocation decisions. From a financial stability perspective, understanding the dynamics of the market liquidity helps to prevent disruptive events, such as the 2010 ‘‘flash crash’’ (CFTC, 2010). Many studies have examined the response of US asset prices to Federal Reserve monetary policy announcements (see, e.g., Rigobon and Sack, 2004; Bernanke and Kuttner, 2005, and references therein). This paper extends the existing literature by examining the impact of monetary news on various measures of market liquidity, such as bid–ask spread, trading volume and depth of the order book.
E-mail address: [email protected]. URL: http://www.federalreserve.gov/econresdata/carlo-rosa.htm. http://dx.doi.org/10.1016/j.econlet.2015.10.029 0165-1765/© 2015 Elsevier B.V. All rights reserved.
This paper examines market liquidity and the dynamics of limit orders in the E-Mini S&P 500 futures market around Federal Reserve announcements using a novel high-frequency dataset for the period from 2008 to 2014. The main findings can be summarized as follows. First, I document that the release of the Federal Open Market Committee (FOMC) statement induces significantly ‘‘higherthan-normal’’ volatility and trading volume. The bid–ask spread is significantly higher in the minutes preceding the release, but it returns to its ‘‘normal’’ level shortly after the release. Second, using order-level data I precisely quantify the dynamics of the limit order book on announcement days. I show that market depth behind the best bid and ask quotes is much lower on event days, hitting an intraday low immediately before the FOMC release at values on average about 20% of the level observed in control days, and gradually recovering to its pre-announcement level. Taken together, these findings suggest that most of the adjustment ahead of monetary news happens through the size of order book entries, rather than through prices (bid–ask spread). The rest of the paper is organized as follows. Section 2 describes the dataset. Section 3 discusses the empirical results. Finally, Section 4 concludes.
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C. Rosa / Economics Letters 138 (2016) 5–8
2. Data The high-frequency data on US stock prices consist of traded price and volume, as well as market depth data (bid and ask prices, and bid and ask quantities up to 10 levels) for the E-Mini S&P 500 (ES) futures security. The sample period is from August 2008 to December 2014, and is determined by data availability.1 All market depth data are time-stamped to the nearest millisecond. Tick data are converted into one-minute series using the previous-tick method, i.e., observations at the end of each one-minute interval are used to generate the series of (equally-spaced) one-minute prices. Trading volume corresponds to the sum of the number of contracts traded during a minute. The choice of one-minute sampling frequency provides a reasonable balance between sampling as finely as possible, and minimizing the impact of the market microstructure noise usually found in very high-frequency data (Bandi and Russell, 2008). At a given point in time, the Chicago Mercantile Exchange (CME) lists five quarterly contracts that can be actively traded. A continuous series is constructed by considering the front-month contract (e.g., the nearest unexpired futures contract in the contract sequence), and rolling over to the next contract on the expiration date. I use the ES security in this study because it is the most popular equity index futures contract in the world, and so it is particularly suitable for analyzing market microstructure issues. For instance, the CME Group noted in its 2015 report (CME Group, 2015) that the E-Mini S&P contract traded, on average, $162 billion in transaction dollar volume per day versus the $21 billion traded by the SPDR S&P 500 Trust (SPY) ETF. Moreover, the ES security can be traded nearly 24/7 during the weekdays on the CME Globex system. Finally, a number of studies (see, e.g., Shyy et al., 1996) document that price movements in the futures markets consistently lead the stock index movements. 3. Results As a preliminary illustration of the effects of Federal Reserve announcements on market quality, Fig. 1 shows the intraday dynamics of the quoted number of September 2013 ES futures contracts on the bid and ask side up to 5 and 10 price levels around the release of the June 2013 FOMC statement.2 The dashed line reports the total market depth for 10 levels on a non-event day. Market depth is lower compared with non-event days and declines sharply immediately before the FOMC release to about 20% of the level observed in control days. This example underscores the fact that the passage of a risk event, such as the FOMC announcement, has a large impact on the depth of the order book of a highly liquid asset. Having illustrated the effect of one FOMC statement on market depth, I now turn to a more systematic analysis of the dynamic behavior of various liquidity measures from 30 min before to one hour after the release of the monetary news. Panel A of Fig. 2 displays the volatility of one-minute stock returns on event days (solid blue line) and non-event days (dashed black line), defined
1 Data on market depth are available from July 3, 2008, for 5 levels, and from February 26, 2010, for 10 levels. The data used in this study are provided by the Chicago Mercantile Exchange via Thomson Reuters. The front-month ES futures contract is extremely liquid: on a random day (July 9th, 2014, which featured median daily volume for 2014), there were roughly 3 million changes in the top 10 levels of the order book. 2 A limit order book is the collection of all active limit orders (i.e., orders to buy a security at no more than a specific price, or to sell a security at no less than a specific price), arranged first by price and then by arrival time. The best (highest) bid and the best (lowest) ask are referred as the top of the book, and together with their associated quantities, they represent level one of the order book. Similarly, level k is the price–quantity pair associated with the kth highest bid and the kth lowest ask.
Fig. 1. Market quality around the June 2013 FOMC announcement. This figure shows the intraday market depth of the front-month of the E-Mini S&P 500 futures contract around the FOMC announcement of June 19, 2013. The blue and red areas represent the number of contracts available on the first five levels of the ask and bid sides of the order book, whereas the light blue and light red areas represent the number of contracts available on levels 6 through 10 of the ask and bid sides of the order book. The dashed black line represents the total number of contracts available on the first 10 levels on a control day (in this case, the previous day). The vertical line is placed at the release time of the FOMC statement (2:00 P.M., Eastern Standard Time). (For interpretation of the references to color in this figure legend, the reader is referred to the web version of this article.)
as the same hours of the day before and after the FOMC meeting day. Panel B displays the median ratio between volumes on event days and control days, and Panel C plots the ratio of the mean bid–ask spreads on event and non-event days.3 Large and small filled squares indicate that the volatility is significantly different in the two subgroups, or that the median ratio of volume and bid–ask spread is significantly different from one, at the 1% and 5% levels, respectively. The volatility of the ES futures one-minute returns suddenly jumps at the time of the release of the FOMC statement, becoming roughly five times larger than usual, and remaining significantly higher for the following hour (see also Rosa, 2013). Trading activity is lower than normal before the release of the FOMC statement, becomes seven times larger at the time of the release, and then gradually returns to its normal level. Finally, Panel C shows that the bid–ask spread is significantly higher in the minutes preceding the release, but it returns to its ‘‘normal’’ level immediately after the release. These results suggest that equity traders take a ‘‘wait-and-see’’ approach leading up to the release of the FOMC statement; they are also consistent with those reported in previous studies, such as Bomfim (2003), who notes that the stock market tends to be relatively quiet before scheduled FOMC policy announcements.4 Chung et al. (2013) also analyze various intraday liquidity measures around FOMC announcements. This paper complements their findings by documenting that the decrease in liquidity associated with policy announcements occurs both before and after FOMC announcements.5 The most novel aspect of the results, however, is the dynamics of limit orders around FOMC announcements. Panel A of Fig. 3
3 As a robustness check, I define as control days the same hours and weekdays of the previous and following week of the FOMC meeting day. Estimation results (available upon request) are very similar to those reported in the main text. 4 Jones et al. (1998) use daily data on Treasury securities for the sample 1979–1995, and document a ‘‘calm-before-the-storm’’ effect on days prior to important macroeconomic announcements. Fleming and Piazzesi (2005) use oneminute Treasury data for the sample 1994 to 2004, and document that bid–ask spreads rise ahead of the FOMC announcement, whereas yield volatility and volumes peak shortly after the announcement. This paper complements those findings by looking at various measures of liquidity conditions in the stock market around FOMC announcements, including the response of the depth of the order book, for a more recent sample (2008–2014). Most aspects of the adjustment process look similar to those reported for Treasury securities. 5 There are a number of differences between this work and Chung et al. (2013). First, this paper documents the dynamics of the order book not only at the best offer and bid quotes, but also behind the best quotes. Second, the sample used in this paper is from 2008 to 2014, rather than from 1995 to 2005. Finally, this paper uses one-minute frequency data, rather than 5-min and 30-min frequency data.
C. Rosa / Economics Letters 138 (2016) 5–8
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Fig. 3. Market quality around the releases. This figure displays the median ratio between market depth on event days and control days, defined as the same hours of the day before and after the FOMC meeting day. Market depth is the number of contracts available on the first five levels of the ask and bid sides of the limit order book. The sample period is August 2008 to December 2014. The interval spans from 30 min before to one hour after the event time. The vertical line is placed at the release time of the FOMC statement (Panel A) or nonfarm payrolls (Panel B). The Wilcoxon signed rank test is employed to test the null hypothesis that the median ratio of announcement days over control days equals one. Large and small filled squares denote significance of the differences at the two-sided 1% and 5% levels, respectively.
Fig. 2. Volatility, volume, and bid–ask spread around the release of the FOMC statement. This figure displays the volatility, trading volume and bid–ask spread around the release of the FOMC statement compared with control days, defined as the same hours of the day before and after the FOMC meeting day. Panel A plots (i) the standard deviation of one-minute stock returns (e.g., percentage changes) on event days with a solid blue line, and (ii) the standard deviation of one-minute stock returns on non-event days with a dashed black line. Panel B plots the median ratio between volumes on event days and control days. Panel C plots the ratio of the mean bid–ask spreads on event and non-event days. The sample period is August 2008 to December 2014. The interval spans from 30 min before to one hour after the event time. The vertical line is placed at the release time of the FOMC statement. For Panel A, the Brown and Forsythe’s (1974) statistic is employed to test the null hypothesis of equal variance in each subgroup. For Panel B, the Wilcoxon signed rank test is employed to test the null hypothesis that the median ratio of announcement days over control days equals one. For Panel C, the Wilcoxon–Mann–Whitney test (with tie correction) is employed to test the null hypothesis that the median on announcement days equals the median on control days. Large and small filled squares denote significance of the differences at the two-sided 1% and 5% levels, respectively.
displays the median ratio between market depth on FOMC meeting days and control days, where market depth represents the number of contracts available on the first five levels of the ask and bid sides of the order book.6 Large and small filled squares indicate that the
6 I examine the robustness of the baseline results along several dimensions: (1) I consider the size of the bid and ask entries of the order book separately; (2) I look at 10 levels of the order book, rather than 5 levels; and (3) I use as a testing security the front-month contract of the e-mini Nasdaq 100 futures, instead of the e-mini S&P 500 futures. Overall, the econometric results remain very similar to those presented in Fig. 3.
median ratio is significantly different from one, at the 1% and 5% levels, respectively. Market depth is much lower on event days, reaching its lowest point immediately before the FOMC release at values on average about 20% of the level observed in control days, and gradually recovering to its pre-announcement level. To investigate whether market quality around monetary news differs from the dynamics featured around macroeconomic releases, I look at the effect of nonfarm payrolls announcements, sometimes called the king of macroeconomic releases (Andersen and Bollerslev, 1998).7 The adjustment process induced by nonfarm payrolls resembles the adjustment to FOMC announcements. However, some aspects, such as the magnitude of the response, look somewhat different. For instance, the volume and the bid–ask spread at the time of nonfarm payrolls release are about 11 and 1.6 times higher than the levels on event days. Moreover, trading volume before the release of nonfarm payrolls is slightly higher on announcement days than on control days (see separate Appendix for further details). Panel B of Fig. 3 displays the median ratio of (total) market depth for five levels on announcement days and non-event days. In this case the market depth reaches a trough immediately before the macro release, at roughly 20% of the level observed in control days, and in about 10 min returns back to the level on nonevent days. One potential explanation of the difference in the post-
7 Erenburg and Lasser (2009) and Scholtus et al. (2014) also document that market quality, measured by spread and depth, deteriorates during macroeconomic releases.
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announcement reaction of nonfarm payrolls compared with FOMC announcements may be that the monetary news is released in the afternoon, so equity traders do not have much time before the end of the trading session to adjust their portfolio holdings. In contrast, nonfarm payrolls are released in the morning, giving traders the entire trading day to adjust their positions.8 4. Conclusion This paper tries to shed some light on the link between monetary announcements and market quality. I document that the release of the FOMC statement induces volatility and trading volume that are significantly ‘‘higher than normal’’, whereas the bid–ask spread is significantly higher immediately before the release of the statement. Using order-level data, I also show that market depth is much lower on event days: it dips appreciably immediately before the FOMC release to about 20% of the level observed in control days, and returns to its pre-announcement level 10 min after the release. Taken together, these results suggest that most of the adjustment ahead of monetary news happens through the size of the order book, rather than through prices (bid–ask spread). Acknowledgments I thank Michael Fleming, Yesol Huh, Tony Rodrigues, and Giovanni Verga for useful comments. I also thank an anonymous referee for detailed comments on an earlier draft of the paper that led to significant improvements. All remaining errors are mine. The views expressed herein are mine alone, and do not reflect the views of the Federal Reserve Board or its staff.
8 The impact of the FOMC minutes (released at 2 p.m., eastern time) on market depth is similar to that of the FOMC statement (results available upon request) and corroborates this explanation. The different response pattern may depend on a number of other aspects, including the direction of the surprise, the relative precision of traders’ prior beliefs, or the presence of potential informational leakages. Note also that the informational content of FOMC announcements differs from that of nonfarm payrolls. The FOMC statement contains not only an assessment of the economy, but also information about the Committee’s reaction function, and it comprises both qualitative (such as the interpretation of incoming data and economic conditions) and quantitative (e.g., target rate decisions and quantity of asset purchases) information.
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