The Rodney L. White Center for Financial Research The Effect of Macroeconomic News on Beliefs and Preferences: Evidence from the Options Market

We examine the effect of regularly scheduled macroeconomic announcements on the beliefs and preferences of participants in the U.S. Treasury market by comparing the option-implied state-price density (SPD) of bond prices shortly before and after the announcements. We find that the announcements reduce the uncertainty implicit in the second moment of the SPD regardless of the content of the news. The changes in the higher-order moments, in contrast, depend on whether the news is good or bad for economic prospects. Using a standard model for interest rates to disentangle changes in beliefs and changes in preferences, we demonstrate that our results are consistent with time-varying risk aversion in the spirit of habit formation. ∗We thank Frank de Jong, Joost Driessen, Michael Fleming, Michael Rockinger, Nick Souleles, and seminar participants at the Bank of Italy, ESSEC, St. Anna School of Advanced Studies, University of Amsterdam, Università Bocconi, University of Georgia, University of Lausanne, and University of Reading. We also thank Tim Bollerslev, Jun Cai, and Frank Song for providing some of the announcement data. Financial support from the Alea Research Center at the University of Trento and the Rodney L. White Center for Financial Research at the University of Pennsylvania is gratefully acknowledged.