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 Yacine Aı̈t-Sahalia, David Bates, Frank de Jong, Joost Driessen, Michael Fleming, Andrew Lo, Michael Rockinger, Nick Souleles, Robert Whaley, and seminar participants at the Bank of Italy, Duke University, ESSEC, St. Anna School of Advanced Studies, University of Amsterdam, Università Bocconi, University of Georgia, University of Lausanne, University of Reading, 2003 meetings of the European Finance Association, and Fall 2003 meeting of the NBER asset pricing group. 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.