FOMC News and Segmented Markets

A growing body of evidence suggests that FOMC announcements can affect private sector beliefs about near-term macroeconomic conditions. We measure index option trader beliefs about the short-horizon implications of central bank policy using the return of short-term dividend strips around each FOMC announcement (we term this short-term dividend strip return, “SDR”). We find that SDR predicts both future firm-level earnings and firm-level earnings announcement returns. Furthermore, using analyst earnings forecasts, we provide evidence of belief underreaction to FOMC announcements. We develop a stylized framework to show how investor specialization and segmented markets can generate our empirical results