Financial Markets and the Macro Economy

The objective of this paper is to provide a deeper insight into the links between financial markets and the real economy. To that end, we study the short-term anticipation and response of U.S. stock, Treasury, and corporate bond markets to the first release of U.S. macroeconomic information. Specifically, we focus on the impact of these announcements not only on the level, but also on the volatility and comovement of those assets’ returns. For that purpose, we estimate several extensions of the parsimonious amended GARCH model of Engle (2002) for the excess holding-period returns on seven portfolios of these asset classes. We find that the process of price formation in the U.S. financial markets appears to be driven by fundamentals. Yet, our analysis reveals a statistically and economically significant dichotomy between the reaction of the stock and bond markets to the arrival of unexpected fundamental information. We also show that stock, Treasury, and corporate bond returns tend to react to the expected component of these announcements as well. Overall, the above results shed new light on the mechanisms by which information is incorporated into prices. JEL classification: C32; G14