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Since the advent of electronic trading in the late 1990s, S&P 500 futures have traded close to 24 hours a day. In this post, which draws on our recent Staff Report, we document that holding U.S. equity futures overnight has earned a large positive return during the opening hours of European markets. The largest positive returns in the 1998–2019 sample have accrued between 2 a.m. and 3 a.m. U.S. Eastern time—the opening of European stock markets—and averaged 3.6 percent on an annualized basis, a phenomenon we call the overnight drift.
The recent era of globalization has witnessed growing cross-country trade integration as firms’ production chains have spread across the world, and with stock market returns becoming more correlated across countries. While research has predominantly focused on how financial integration impacts the propagation of shocks across international financial markets, trade also influences these cross-border spillovers. In particular, one important aspect, highlighted by the recent work of di Giovanni and Hale (2020), is how the global production network influences the transmission of U.S. monetary policy to world stock markets.
“U.S. stocks are racing toward a second consecutive quarter of dramatic gains, continuing a historic stock-market recovery that few predicted in the depths of the March downturn,” said a September Wall Street Journal article. “The stock market is detached from economic reality. A reckoning is coming,” said the Washington Post. What is going on? In this post, I look not at what stocks have actually done or will do, but at what investors expected should have happened, and what they expect will happen going forward. It turns out that, at least by the particular measure of expectations I consider, investors expected stock returns to be high all along and continue to expect the same in the future.
Olivier Armantier, Michael Neubauer, Daphne Skandalis, and Wilbert van der Klaauw
Second of two posts
In the months leading up to the 2018 midterm elections, were economic expectations in congressional districts about to elect a Republican similar to those in districts about to elect a Democrat? How did economic expectations evolve in districts where the party holding the House seat would switch? After examining the persistence of polarization in expectations using voting patterns from the presidential election in our previous post, we explore here how divergence in expectations may have foreshadowed the results of the midterm elections. Using the Survey of Consumer Expectations, we show that economic expectations deteriorated between 2016 and 2018 in districts that switched from Republican to Democratic control compared to districts that remained Republican.
Erin Denison, Michael J. Fleming, and Asani Sarkar
Fifth of five posts
In our previous post, we assessed losses to customers and clients from foregone opportunities after Lehman Brothers filed for bankruptcy in September 2008. In this post, we examine losses to Lehman and its investors in anticipation of bankruptcy. For example, if bankruptcy is expected, Lehman’s earnings may decline as customers close their accounts or certain securities (such as derivatives) to which Lehman is a counterparty may lose value. We estimate these losses by analyzing Lehman’s earnings and stock, bond, and credit default swap (CDS) prices.
Fernando M. Duarte, Juan Navarro-Staicos, and Carlo Rosa
Volatility, a measure of how much financial markets are fluctuating, has been near its record low in many asset classes. Over the last few decades, there have been only two other periods of similarly low volatility: in May 2013, and prior to the financial crisis in 2007. Is there anything we can learn from the recent period of low volatility versus what occurred slightly more than one year ago and seven years ago? Probably; the current volatility environment appears quite similar to the one in May 2013, but it’s substantially different from what happened prior to the financial crisis.
As we observed in our last post on the Continental Currency Crisis, the finances of the United States remained chaotic through the 1780s as the young government moved to establish its credit. U.S. Congress was finally given the power of taxation in 1787 and, in 1789, Alexander Hamilton was appointed as the first Secretary of the Treasury. Hamilton moved quickly to begin paying off war debts and to establish a national bank—the Bank of the United States. But in 1791, a burst of financial speculation in subscription rights to shares in the new bank caused a tangential rally and fall in public debt securities prices. In this edition of Crisis Chronicles, we describe how Hamilton invented central bank crisis management techniques eight decades before Walter Bagehot described them in Lombard Street.
Stock market circuit breakers halt trading activity on a single stock or an entire exchange if a sudden large price move occurs. Their purpose is to forestall cascading trading activity caused by gaps in liquidity or order errors. Whether circuit breakers achieve this goal is contentious. This post adds to the debate by analyzing intraday price formation on the Tokyo Stock Exchange (TSE) on May 23, 2013—the pinnacle of this past year’s volatility in Japanese stock markets. While no circuit breakers were triggered on the TSE, we focus on trading conditions before and after the daily lunch break, which halted trading amid heightened market volatility on that day. The data seem to indicate that the break did not stem price volatility; rather, its anticipation may have worsened trading conditions.
We surveyed banks, we combed the academic literature, we asked economists at central banks. It turns out that most of their models predict that we will enjoy historically high excess returns for the S&P 500 for the next five years. But how do they reach this conclusion? Why is it that the equity premium is so high? And more importantly: Can we trust their models?
For many years, economists have struggled to explain the “equity premium puzzle”—the fact that the average return on stocks is larger than what would be expected to compensate for their riskiness. In this post, which draws on our recent New York Fed staff report, we deepen the puzzle further. We show that since 1994, more than 80 percent of the equity premium on U.S. stocks has been earned over the twenty-four hours preceding scheduled Federal Open Market Committee (FOMC) announcements (which occur only eight times a year)—a phenomenon we call the pre-FOMC announcement “drift.”
Liberty Street Economics features insight and analysis from New York Fed economists working at the intersection of research and policy. Launched in 2011, the blog takes its name from the Bank’s headquarters at 33 Liberty Street in Manhattan’s Financial District.
The editors are Michael Fleming, Andrew Haughwout, Thomas Klitgaard, and Asani Sarkar, all economists in the Bank’s Research Group.
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