Finance and Economics Discussion Series (FEDS)
Words Speak as Loudly as Actions: Central Bank Communication and the Response of Equity Prices to Macroeconomic Announcements
While the literature has already widely documented the effects of macroeconomic news announcements on asset prices, as well as their asymmetric impact during good and bad times, we focus on the reaction to news based on the description of the state of the economy as painted by the Federal Open Market Committee (FOMC) statements. We develop a novel FOMC sentiment index using textual analysis techniques, and find that news has a bigger (smaller) effect on equity prices during bad (good) times as described by the FOMC sentiment index. Our analysis suggests that the FOMC sentiment index offers a reading on current and future macroeconomic conditions that will affect the probability of a change in interest rates, and the reaction of equity prices to news depends on the FOMC sentiment index which is one of the best predictors of this probability.
Keywords: Monetary policy, public information, probability of a recession, price discovery.
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