How News Affects Markets

Time, Time Management, Stopwatch, Industry, Economy

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Tyler Cowen linked to a new NBER study by Scott R. Baker, Nicholas Bloom, Steven J. Davis, and Marco C. Sammon, which looks at the response of asset prices to various types of news. Here I’ll discuss the paper’s abstract:

We examine next-day newspaper accounts of large daily jumps in 16 national stock markets to assess their proximate cause, clarity as to cause, and the geographic source of the market-moving news. Our sample of 6,200 market jumps yields several findings. First, policy news – mainly associated with monetary policy and government spending – triggers a greater share of upward than downward jumps in all countries.

I’m not surprised that monetary policy is important, or that the effects are asymmetric. While one can find occasional examples of markets falling sharply on monetary policy announcements, as in December 2007, major changes are usually in the upward direction. This is because bad monetary policy generally involves errors of omission—the central bank fails to adjust its policy rate when the natural rate of interest is falling (as in mid-2008.) When the central bank does make a major move, it generally helps the situation. The problem, of course, is that central banks are too passive; too unwilling to move when economic conditions change.

Second, the policy share of upward jumps is inversely related to stock market performance in the preceding three months. This pattern strengthens in the postwar period.

Beneficial policy adjustments are less likely to occur if the economy (and the markets) has previously been doing well.

Third, market volatility is much lower after jumps triggered by monetary policy news than after other jumps, unconditionally and conditional on past volatility and other controls. Fourth, greater clarity as to jump reason also foreshadows lower volatility.

A monetary policy announcement often helps to clarify the situation. Other shocks, such as the failure of Lehman Brothers, make the situation even more confusing.

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