Does Fed communication affect uncertainty and risk aversion?

Chau, Frankie; Deesomsak, Rataporn; Shaikh, Raja

Abstract

This paper examines whether the Federal Reserve (Fed) communication has significant impact on the level of uncertainty and risk aversion in the U.S., U.K., and Eurozone equity markets. We first apply computational linguistic tools to the Federal Open Market Committee (FOMC) meeting minutes to measure the tone of Fed communication and then decompose the optionimplied volatility into proxies for risk aversion and expected market volatility (“uncertainty”). We provide novel evidence that the Fed's optimistic tone decreases both uncertainty and risk aversion in global equity markets, with the former effect being stronger. We also find a stronger response of market participants to central bank communication during recessions and in periods of high policy uncertainty. Further analysis reveals that, in formulating their risk preferences, investors pay particular attention to FOMC's discussion about financial market, credit condition, employment, and growth. Overall, our results suggest that central bank communication plays
an important role in shaping perceptions and risk appetite of financial market participants.

Citation

Chau, F., Deesomsak, R., & Shaikh, R. (in press). Does Fed communication affect uncertainty and risk aversion?. Review of Quantitative Finance and Accounting,

• Journal Article Type: Article
• Acceptance Date: Jun 20, 2024
• Deposit Date: Jun 24, 2024
• Journal: Review of Quantitative Finance and Accounting
• Print ISSN: 0924-865X
• Publisher: Springer
• Peer Reviewed: Peer Reviewed
• Public URL: https://durham-repository.worktribe.com/output/2499794