What’s Priced? Estimating Market Mispricing of Macroeconomic News

Abstract

Delineating between fundamental and nonfundamental price moves is vital for investment practitioners because the former tend to be more persistent than the latter. This article describes an approach to isolating price moves that are driven by fundamental macroeconomic news. The authors use an event-study methodology at the intraday frequency to estimate typical reactions to macro news releases for a set of seven equity and six government bond markets. These are calculated on an expanding-window and exponentially weighted basis to account for time variation in these reactions. The primary innovation of this work is a measure of market mispricing that looks at deviations of market returns from the returns expected based on the authors’ estimated coefficients, which they calculate for each of these markets from 2015 to 2019. This measure provides an input for discretionary tactical asset allocation decisions. The correlation of this market mispricing measure with future returns provides support for the thesis that initial time-series momentum and later time-series reversion of asset returns reflect nonfundamental factors.

TOPICS: Derivatives, financial crises and financial market history

Key Findings

• • Because nonfundamental price moves mean revert faster than fundamental price moves, the R² of macro news is higher at a low frequency than at a high frequency.

• • Intraday estimates of market price responses to macro news are more accurate than estimates based on daily time series because a short event-study window reduces concerns around endogeneity.

• • These intraday estimates can be used to now-cast market returns and find the deviation of those now-casts from actual returns. Cumulating these deviations over months of data indicates whether markets are mispriced relative to macro fundamentals.

• • Our measure of market mispricing is predictive of future asset returns and provides broader context to discretionary tactical asset allocation decisions.

• • This measure also reveals more cleanly than previous research the time-series properties of nonfundamental price moves, with initial time-series momentum and later time-series reversal.