Real-time price discovery in global stock, bond and foreign exchange markets

Transcription

1 Auhor's personal copy Journal of Inernaional Economics 73 (2007) Real-ime price discovery in global sock, bond and foreign exchange markes Torben G. Andersen a,e, Tim Bollerslev b,e, Francis X. Diebold c,e,, Clara Vega d a Deparmen of Finance, Norhwesern Universiy, Unied Saes b Deparmens of Economics and Finance, Duke Universiy, Unied Saes c Deparmens of Economics, Finance and Saisics, Universiy of Pennsylvania, Unied Saes d Deparmen of Finance, Universiy of Rocheser, Unied Saes e NBER, Unied Saes Received 25 Augus 2005; received in revised form 5 Sepember 2006; acceped 26 February 2007 Absrac Using a unique high-frequency fuures daase, we characerize he response of U.S., German and Briish sock, bond and foreign exchange markes o real-ime U.S. macroeconomic news. We find ha news produces condiional mean jumps; hence high-frequency sock, bond and exchange rae dynamics are linked o fundamenals. Equiy markes, moreover, reac differenly o news depending on he sage of he business cycle, which explains he low correlaion beween sock and bond reurns when averaged over he cycle. Hence our resuls qualify earlier work suggesing ha bond markes reac mos srongly o macroeconomic news; in paricular, when condiioning on he sae of he economy, he equiy and foreign This work was suppored by he Naional Science Foundaion, he Guggenheim Foundaion, he BSI Gamma Foundaion, and CREATES. For useful commens we hank he Edior and referees, seminar paricipans a he Bank for Inernaional Selemens, he BSI Gamma Foundaion, he Symposium of he European Cenral Bank/Cener for Financial Sudies Research Nework, he NBER Inernaional Finance and Macroeconomics program, and he American Economic Associaion Annual Meeings, as well as Rui Albuquerque, Annika Alexius, Boragan Aruoba, Anirvan Banerji, Ben Bernanke, Rober Connolly, Jeffrey Frankel, Lingfeng Li, Richard Lyons, Marco Pagano, Paolo Pasquariello, and Neng Wang. Corresponding auhor. Deparmen of Economics, Universiy of Pennsylvania, 3718 Locus Walk Philadelphia, PA , Unied Saes. Tel.: ; fax: addresses: -andersen@kellogg.nwu.edu (T.G. Andersen), boller@econ.duke.edu (T. Bollerslev), fdiebold@sas.upenn.edu (F.X. Diebold), vega@simon.rocheser.edu (C. Vega) /$ - see fron maer 2007 Elsevier B.V. All righs reserved. doi: /j.jineco

2 Auhor's personal copy 252 T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) exchange markes appear equally responsive. Finally, we also documen imporan conemporaneous links across all markes and counries, even afer conrolling for he effecs of macroeconomic news Elsevier B.V. All righs reserved. Keywords: Asse pricing; Macroeconomic news announcemens; Financial marke linkages; Marke microsrucure; High-frequency daa; Survey daa; Asse reurn volailiy; Forecasing JEL classificaion: F3; F4; G1; C5 1. Inroducion How do markes arrive a prices? There is perhaps no quesion more cenral o economics. This paper focuses on price formaion in financial markes, where he quesion looms large: How, if a all, is news abou macroeconomic fundamenals incorporaed in pricing socks, bonds and foreign exchange? Unforunaely, he process of price discovery in financial markes remains poorly undersood. Tradiional efficien markes hinking suggess ha asse prices should compleely and insananeously reflec movemens in underlying fundamenals. Conversely, ohers feel ha asse prices and fundamenals may be largely and rouinely disconneced. Experiences such as he lae 1990s U.S. marke bubble would seem o suppor ha view, ye simulaneously i seems clear ha financial marke paricipans pay a grea deal of aenion o daa on underlying economic fundamenals. The noable difficuly of empirically mapping he links beween economic fundamenals and asse prices is indeed sriking. The cenral price-discovery quesion has many dimensions and nuances. How quickly, and wih wha paerns, do adjusmens o news occur? Does announcemen iming maer? Are he magniudes of effecs similar for good news and bad news, or, for example, do markes reac more vigorously o bad news han o good news? Quie apar from he direc effec of news on asses prices, wha is is effec on financial marke volailiy? Do he effecs of news on prices and volailiy vary across asses and counries, and wha are he links? Are here readily idenifiable herd behavior and/or conagion effecs? Do news effecs vary over he business cycle? Jus as he cenral quesion of price discovery has many dimensions and nuances, so oo does a full answer. Appropriaely hen, dozens perhaps hundreds of empirical papers chip away a he price discovery quesion, bu mos fall shor of our goals in one way or anoher. Some examine he connecion beween macroeconomic news announcemens and subsequen movemens in asse prices, bu only for a single asse class and counry (e.g., Balduzzi e al., 2001, who sudy he U.S. bond marke). Ohers examine muliple asse classes bu only a single counry (e.g., Boyd e al., 2005, who sudy U.S. sock and bond markes). Sill ohers examine muliple counries bu only a single asse class (e.g., Andersen e al., 2003b, who sudy several major U.S. dollar exchange raes). Now, however, professional aenion is urning oward muliple counries and asse classes. 1 Our paper is firmly in ha radiion. We progress by sudying a broad se of counries and asse classes, characerizing he join response of foreign exchange markes as well as he domesic and foreign sock and bond markes o real-ime U.S. macroeconomic news. We simulaneously 1 Noably, for example, in conemporaneous and independen work, Faus, Rogers, Wang, and Wrigh (2007) use he lens of uncovered ineres rae pariy o examine he news responses of bond yield curves (in he U.S., Germany and he U.K.) and he corresponding dollar exchange raes.

3 Auhor's personal copy T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) Table 1 Fuures conracs Fuures conrac 1 Exchange 2 Trading hours 3 Sample 4 Liquidiy 5 $/Pound CME 8:20 15:00 01/92 12/ $/Yen CME 8:20 15:00 01/92 12/ $/Euro 6 CME 8:20 15:00 01/92 12/ S&P500 CME/GLOBEX 8:20 16: /94 12/ Year U.S. Treasury Bond CBOT 8:20 15:00 01/92 12/ Briish Long Gil 8 LIFFE 3:00 13:00 07/98 12/ Euro Bobl 9 EUREX 2:00 13:00 07/98 12/ FTSE LIFFE 3:00 12:30 07/98 12/ DJ Euro Soxx EUREX 3:00 14: /98 12/ The delivery monhs for all of he conracs are March, June, Sepember and December. We always use he conrac closes o expiraion, which is generally he mos acively raded, swiching o he nex-mauriy conrac five days before expiraion. 2 Chicago Mercanile Exchange (CME), Chicago Board of Trade (CBOT), London Inernaional Financial Fuures Exchange (LIFFE), European Exchange (EUREX). 3 Open aucion regular rading hours, Easern Sandard Time. 4 Saring and ending daes of our daa sample. 5 Average number of daily ransacions in he common sample 07/98 o 12/02, 8:20 o 12:30 EST. 6 Prior o June 1, 1999, we use $/DM fuures. 7 The S&P500 daa from 8:20 o 9:30 comes from GLOBEX. 8 The Briish Long Gil conrac is based on he Briish 10-Year Treasury Noe. 9 The Euro Bobl conrac is based on he German 5-Year Treasury Noe. 10 The FTSE 100 index is consruced from he 100 larges U.K. companies. 11 The DJ Euro Soxx 50 index is composed of he 50 larges blue-chip marke secor leaders in coninenal Europe. In July 2003 he index was composed of one Belgian, welve German, five Spanish, one Finish, seveneen French, seven Ialian and seven Duch companies. 12 EUREX exended he DJ Euro Soxx 50 rading hours from 4:00 11:00 EST o 3:00 11:00 EST on Ocober 18, 1999, again from 3:00 11:00 EST o 3:00 11:30 EST on January 24, 2000, and ye again from 3:00 11:30 EST o 3:00 14:00 EST on January 2, combine: (1) high-qualiy and ulra-high frequency asse price daa across markes and counries, which allows us o sudy price movemens in (near) coninuous ime; (2) a very broad se of synchronized survey daa on marke paricipans' expecaions, which allow us o infer surprises or innovaions when news is announced; and (3) advances in saisical modeling of volailiy, which faciliae efficien inference. We proceed in sraighforward fashion: In Secion 2 we describe our daa. In Secion 3 we presen our basic resuls, and in Secion 4 we presen resuls obained using a generalized model specificaion. We conclude in Secion High-frequency reurn daa Here we discuss our reurn daa. We begin by describing is sources and consrucion, and hen we examine is feaures, sressing various correlaions during news announcemen imes, ulimaely allowing for differen correlaion srucures in expansions vs. conracions Fuures marke reurn daa We use fuures marke daa for several reasons. Firs, fuures prices are readily available on a ick-by-ick basis. Second, mos significan U.S. macroeconomic news announcemens are

4 Auhor's personal copy 254 T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) Table 2 Summary saisics for five-minue sock, bond and forex reurns Mean Maximum Minimum Sd. dev. Skewness Kurosis $/Pound $/Yen $/Euro S&P FTSE DJ Euro Soxx Year Treasury Bond Briish Long Gil German Euro Bobl See he noes o Table 1 for a descripion of he differen conracs. The summary saisics are based on he 15,764 fiveminue reurns en minues before and one-and-a-half hours afer he release of each of he U.S. macroeconomic announcemens described in Table 4. The full common sample for all of he conracs used in he calculaions spans July 1, 1998 hrough December 31, released a 8:30 Easern Sandard Time (EST) when he fuures markes are open, bu he equiy markes closed. Third, ransacion coss are lower in he fuures markes, and he conracs we analyze are very acively raded. Indeed, numerous sudies find ha fuures markes end o lead cash markes in erms of price discovery. 2 This is imporan, as we focus on price adjusmens measured over very shor ime inervals. Table 1 provides an overview of he specific conracs, he exchanges on which hey rade, and heir rading hours, along wih he average number of conracs raded daily. The S&P500, $/ Pound, $/Yen and $/Euro fuures conracs are lised on he Chicago Mercanile Exchange (CME). 3 Trading in he foreign exchange conracs sars a 8:20 EST, while he regular rading hours for S&P500 are 9:30 o 16:15 EST. However, beginning January 2, 1994, GLOBEX offered auomaed pre-marke rading in he S&P500 fuures conrac, so we use he GLOBEX ransacions daa o sar he S&P500 rading day a 8:20 EST. Our daa for he 30-Year U.S. Treasury Bond fuures conrac comes from he Chicago Board of Trade (CBOT) whose rading hours coincide wih hose of he CME. The FTSE 100 and he Briish Long Gil fuures conracs rade on he London Inernaional Financial Fuures Exchange (LIFFE). The FTSE 100 index is based on he one-hundred larges U.K. companies, while he Long Gil conrac is based on he Briish 10-Year Treasury noe. Trading on LIFFE opens a 8:00 GMT, or 3:00 EST. Boh of our las wo conracs, he DJ Euro Soxx 50 (DJE) and he Euro Bobl fuures, rade on he European Exchange (EUREX). The DJE index is composed of he fify larges blue-chip marke secor leaders in he Euro-zone counries. The Euro Bobl is based on he German 5-Year Treasury noe. We obained raw ick-by-ick ransacion prices for all conracs from Tick Daa Inc. The sample for he foreign exchange raes and he U.S. Treasury Bond conracs spans January 2, 1992 hrough December 31, Because of he need for pre-marke GLOBEX daa o augmen he rading day, our sample for he S&P500 sars wo years laer on January 2, Daa on he four European conracs are only available from July 1, 1998 hrough December 31, See, for example, Hasbrouck (2003). 3 The reurns for he $/Euro are based on he $/DM conrac prior o June 1, Boh conracs raded acively before and afer his dae, bu he liquidiy sared o swich from he $/DM o he $/Euro around ha ime.

5 Auhor's personal copy T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) All resuls repored below are based on five-minue local currency coninuously compounded reurns, log(p / p 1 ), where p denoes he price of he las rade in he 'h five-minue inerval. 4 If no rade occurs in a given five-minue inerval, we use he price from he previous inerval, as long as he previous price was quoed wihin he las half-hour. We include only he days where here were a leas one rade every half-hour. We always use he mos acively raded neares-o-mauriy conrac, swiching o he nex-mauriy conrac five days before expiraion High-frequency reurns around macroeconomic news announcemens Table 2 repors summary saisics for he five-minue reurn series around he announcemen imes. Since our news announcemen regressions are based on he period ranging from en minues before o one-and-a-half hours afer an announcemen, we le he sample cover his se of reurns only. Moreover, o provide a meaningful benchmark for he subsequen resuls based on simulaneous esimaion across all he markes, we furher resric he sample for all conracs o July 1, 1998 o December 31, 2002, he period available for he shores series, namely he European markes. The average five-minue reurn for each of he nine markes is, as expeced, exremely close o zero. However, he (absolue) size of he larges five-minue reurns is noeworhy, wih he exreme reurn even being abou en sandard deviaions or more removed from he sample mean for all markes. For he S&P500 and he DJE hese exreme moves exceed wo percen. This immediaely suggess ha macroeconomic news does move he markes. 5 The summary saisics confirm he usual rank ordering in erms of volailiy, wih sock markes being he mos volaile, followed by foreign exchange raes, and hen fixed income. The only excepion o his rule is he U.S. T-Bond marke, for which he uncondiional reurn sandard deviaion acually exceeds he sandard deviaions for he hree exchange raes. This is likely a consequence of he fac ha he T-Bond marke, as discussed furher below, reacs mos srongly o macroeconomic news. To provide a sense of he comovemens among he asse markes during news announcemen imes, Table 3 repors uncondiional sample correlaions. All correlaions wihin each of he hree asse classes are posiive. For insance, he sock marke correlaions range from a low of 0.42 beween he S&P500 and he FTSE 100, o a high of 0.54 for he FTSE 100 and he DJE. Similarly, he correlaion beween he reurns for he U.S. T-Bond and he Briish Long Gil is 0.53, while he Gil and German Euro Bobl correlaion is The posiive bond marke crosscorrelaions during U.S. macroeconomic news announcemen imes mach sandard heoreical predicions, such as hose of Lucas (1982). 6 The posiive equiy marke cross-correlaions are 4 Five-minue reurns srike a reasonable balance beween confounding marke microsrucure effecs by sampling oo frequenly and blurring specific price reacions when sampling oo infrequenly; see e.g., he relaed discussions in Andersen e al. (2003b), Bandi and Russell (2004), Hansen and Lunde (2006) and Aï-Sahalia, Mykland and Zhang (2005), among ohers. 5 This is consisen wih Fair (2002), who finds mos large moves in high-frequency S&P500 reurns o be readily idenified wih U.S. macroeconomic news announcemens. Similar resuls for he DM/$ foreign exchange and U.S. T- Bond markes are repored in Andersen and Bollerslev (1998) and Bollerslev, Cai and Song (2000). 6 Alernaively, he posiive bond marke correlaion is also consisen wih he U.S. ineres rae effecively serving as he world ineres rae, as assumed in numerous heoreical models; see also Blanchard and Summers (1984) and he more recen discussion in Chinn and Frankel (2004).

6 Auhor's personal copy 256 T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) Table 3 Uncondiional correlaion marix for five-minue sock, bond and forex reurns $/Pound $/Yen $/Euro S&P500 FTSE 100 DJ Euro Soxx 50 >30-Year Treasury Bond Briish Long Gil German Euro Bobl Full sample $/Pound $/Yen $/Euro S&P FTSE DJ Euro Soxx Year Treasury Bond Briish Long Gil German Euro Bobl Expansion sample $/Pound $/Yen $/Euro S&P FTSE DJ Euro Soxx Year Treasury Bond Briish Long Gil German Euro Bobl Conracion sample $/Pound $/Yen $/Euro S&P FTSE DJ Euro Soxx Year Treasury Bond Briish Long Gil German Euro Bobl See he noes o Table 1 for a descripion of he differen conracs. The uncondiional cross correlaions are based on he 15,764 five-minue reurns en minues before and one-and-a-half hours afer he release of each of he U.S. macroeconomic announcemens described in Table 4. The full common sample spans July 1, 1998 hrough December 31, The expansion period spans July 1, 1998 hrough February 28, 2001, for a oal of 9301 five-minue reurns. The conracion period spans March 1, 2001 o December 31, 2002, for a oal of 6463 five-minue reurns.

7 Auhor's personal copy T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) similarly consisen wih he Lucas model, alhough hey are no direcly implied by i as hree separae influences deermine he equiy prices: he risk-free ineres rae, expeced fuure cash flows and he equiy risk premium. Sock marke prices around he world would end o be posiively correlaed if he discoun rae is he dominan effec or if he domesic and foreign real oupu and/or moneary shocks are posiively correlaed. 7 The cross correlaions beween he differen asse ypes are generally much smaller han he cross correlaions wihin he same asse caegory across counries. Given our American exchange rae quoaion convenion ($/Euro, $/Pound, $/Yen), he negaive correlaions beween he S&P500 and he exchange raes imply ha U.S. macroeconomic news affecs he Dollar and he equiy marke in he same direcion. Ineresingly, a Dollar appreciaion also is associaed wih sock marke increases abroad, even hough one may expec he Dollar o depreciae agains he Pound (Euro) when he FTSE 100 (DJE) prices are rising. This again suggess ha he U.S. macroeconomic fundamenals exer a dominan effec during he news announcemen period. I also serves as a warning ha i may be imporan o conrol explicily for macroeconomic fundamenals when inerpreing asse marke correlaions. Subsequenly we aemp o do so in a simulaneous equaions seing Correlaions in expansions vs. conracions I is ineresing o ask wheher he ineracions among asse reurns and heir responses o macroeconomic fundamenals vary sysemaically across he business cycle. For a preliminary look a his issue, he boom panels in Table 3 repor he uncondiional correlaions separaely for he expansion period from July 1998 hrough February 2001 and he conracion period from March 2001 hrough December During he expansion, he sock-bond correlaions are posiive albei small, whereas during he conracion hey are negaive and large. We canno claim his as a general paern, as we only have daa for one expansion and one conracion. Sill, one possible explanaion is ha he cash flow effec dominaes during conracions while he discoun effec dominaes in expansions (due o cenral bank policy), producing posiive sock-bond reurn correlaions during expansions and negaive in conracions, in confirmaion of he seminal conribuion of Boyd, Jagannahan, and Hu (2005). In wha follows, we explore ha possibiliy in deph. 3. Asse reurns and macroeconomic surprises: basic resuls Here we characerize he dynamic effecs of U.S. macroeconomic news announcemens for each of our nine asse markes. We begin by describing our measuremen of macroeconomic 7 Alhough he high posiive conemporaneous correlaion across counries may be explained by he common bond marke response o U.S. macroeconomic news, a number of oher influences, including marke microsrucure, conagion, and cross-marke hedging effecs, as discussed for example in Fleming, Kirby and Osdiek (1998), could also accoun for he high-frequency correlaions. In he empirical analysis below we aemp o idenify he impac of news direcly. 8 We define conracions as beginning when here are hree consecuive monhly declines in nonfarm payroll employmen, and ending when here are hree consecuive monhly increases in nonfarm payroll employmen. Conracions so-deermined mach closely hose designaed by he NBER over he poswar period. The conracion daes in our sample, moreover, remain unchanged if we adop an alernaive crierion of hree consecuive monhly declines in indusrial producion.

8 Auhor's personal copy 258 T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) news, and hen we esimae responses of asse reurns o news, boh over he full sample and separaely for expansions and conracions Macroeconomic news We use he Inernaional Money Marke Services (MMS) real-ime daa on expeced and realized U.S. macroeconomic fundamenals, defining news as he difference beween he survey expecaions and he subsequenly announced realizaions. The MMS sample covers he period from January 1, 1992 hrough December 31, Table 4 provides a basic descripion of he announcemen releases, including he number of observaions, he agency reporing he news, and he ime of he release. 9 The unis of measuremen obviously differ across he macroeconomic indicaors. Hence, o allow for meaningful comparisons of he esimaed news response coefficiens across indicaors and asse classes, we follow Balduzzi, Elon, and Green (2001) and Andersen e al. (2003b) (2003) in he use of sandardized news. Specifically, we divide he surprise by is sample sandard deviaion, defining he sandardized news associaed wih indicaor k a ime as S k = (A k E k )/σˆ k, where A k denoes he announced value of indicaor k, E k refers o he marke's expecaion of indicaor k as disilled in he MMS median forecas, and σˆ k is equal o he sample sandard deviaion of he surprise componen, A k E k. Because σˆ k is consan for any indicaor k, his sandardizaion affecs neiher he saisical significance of he esimaed response coefficiens nor he fi of he regressions compared o he resuls based on he raw surprises Dynamic news effecs In order o analyze dynamic news effecs, we esimae response equaions using he wo fiveminue reurns direcly preceding and he eigheen five-minue reurns following each announcemen. 10 To allow explicily for cross-marke linkages and dynamic responses o news, we model he condiional mean of he five-minue reurn for asse h, R h, as a linear funcion of I lags of all reurns, ogeher wih J lags of each of he K news announcemens. (There are H = 9 differen asses.) Specifically, R h ¼ b h 0 þ XH i þ XK X J b h kj S k; j þ e h ; ¼ 1; N ; T; ð3:1þ where R h =log(p h /p h 1 ) denoes he five-minue fuures reurn corresponding o asse h (h=$/bp, $/Yen, $/Euro, S&P500, T-Bond, Gil, Bobl, FTSE, and DJE) from ime o ime +1, S k refers o he sandardized news for indicaor k (k=1,, 25) a ime, and he esimaes are based on only hose observaions (R h, S k ) where an announcemen was made a ime. Because he consumer credi, governmen budge, and federal funds rae figures are released inheafernoon,whenliffeandeurexareclosed,wehaveaoalofk =22 indicaors. 9 Wih he excepion of he money supply figures, which are released a 16:30 EST afer he fuures markes have closed, he indicaors lised in Table 4 include all regularly-scheduled major U.S. macroeconomic news announcemens. For a deailed descripion, including a discussion of he properies of he median expecaions, see Andersen e al. (2003b). 10 Hence he pos-announcemen window is one and one-half hours. Some preliminary experimenaion revealed ha our chosen pre- and pos-even windows were more han adequae o capure he sysemaic news responses.

9 Auhor's personal copy T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) Guided by he Schwarz and Akaike informaion crieria, we uniformly fix he wo lag lenghs a I =2 and J =3, resuling in a oal of 107 regression coefficiens o be esimaed for each of he nine asses. We perform boh full-sample regressions and spli-sample regressions (expansion/ conracion, wih he full sample July 1, 1998 hrough December 31, 2002, and he expansion and conracion periods based on he observaions before and afer February 28, 2001, respecively. This leaves us wih a full sample of T = 15,764= fiveminue reurn observaions, reflecing 544 days wih only one macroeconomic announcemen released on ha day (20 observaions per day), 40 days wih wo announcemens, one a 8:30 EST and he oher one a 9:15 EST (29 observaions per day), and 98 days wih wo announcemens, one a 8:30 EST and he oher a 10:00 EST (38 observaions per day). The expansion sample is comprised of he firs 9301 observaions, while he las 6463 observaions consiue he conracion sample. Alhough ordinary leas squares (OLS) would be consisen for he parameers in Eq. (3.1), he disurbance erms for he five-minue reurn regressions are clearly heeroskedasic. Thus, o enhance he efficiency of he coefficien esimaes, we use a wo-sep weighed leas squares (WLS) procedure. We firs esimae he condiional mean model by OLS. We hen use he absolue value of he regression residuals, εˆ h, o esimae a ime-varying volailiy funcion, which we hen subsequenly use o perform weighed leas squares esimaion of Eq. (3.1). We approximae he emporal variaion in he five-minue reurn volailiy around he announcemen imes by he relaively simple regression model, V jê h j¼xi b hi jê h i jþxd d¼1 g d D d þ XK d X J V j V¼0 g h kj V D k; j Vþ u h : ð3:2þ The I =9 own lags of he absolue value of he residuals capures serial correlaion, or ARCH effecs. The nex erm involves D =38 dummy variables for each of he five-minue inraday inervals. This erm direcly accouns for he well-documened inradaily volailiy paerns; see, e.g., he discussion and references in Andersen and Bollerslev (1998). Thelas summaion reflecs dummy variables for each of he announcemen surprises, D k,,upoalag lengh of J =14. There are only K d =20 such dummies as capaciy uilizaion and indusrial producion, and personal consumpion expendiures and personal income, are announced a he same ime. 11 Because he model in Eq. (3.1) conains so many variables and lags, i is counerproducive o repor all he parameer esimaes. 12 Insead, in Fig. 1A C, we presen graphically he poin esimaes for he news response coefficiens, β h kj, j=0,, 3, for some key indicaors a he ime of he news releases and fifeen minues hereafer (dos), along wih corresponding robus nineypercen confidence bands (dashes). Fig. 1A covers he full sample, while he resuls for he 11 We also experimened wih oher lag lenghs and alernaive volailiy specificaions, direcly including he absolue value of he surprise componen, S k,, insead of he news announcemen dummies, D k,. However, he fi was generally bes for he model in Eq. (3.2), alhough he corresponding esimaes for he mean parameers in Eq. (3.1) were essenially unchanged. This is consisen wih he earlier empirical resuls for he spo foreign exchange marke in Andersen e al. (2003b) ha he mere presence of an announcemen, quie apar from he size of he corresponding surprise, end o boos volailiy; see also he discussion in Rich and Tracy (2003). 12 Deails regarding he parameer esimaes, including hose of Eq. (3.2), are available upon reques.

10 Auhor's personal copy 260 T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) expansion and conracion periods appear in Fig. 1B and C. All figures conain hree panels; he firs displays he news responses for he domesic and foreign bond markes, he second focuses on he foreign exchange markes, and he las repors he resuls for he domesic and foreign equiy markes. Consider firs he bond marke responses. The immediae reacions are qualiaively similar o hose discussed earlier for he U.S. T-bond marke over he longer eleven-year sample. Regardless of he sage of he business cycle, posiive real shocks and inflaionary shocks produce lower bond prices, or higher yields. No surprisingly, he effecs are clearly he Table 4 U.S. news announcemens Announcemen Obs. 1 Source 2 Daes 3 Announcemen ime 4 Sd. dev. 5 Quarerly announcemens 1 GDP advance 51 BEA 01/92 12/02 8: GDP preliminary 50 BEA 01/92 12/02 8: GDP final 51 BEA 01/92 12/02 8: Monhly announcemens Real aciviy 4 Nonfarm payroll employmen 194 BLS 01/92 12/02 6 8: Reail sales 193 BC 01/92 12/02 8: Indusrial producion 193 FRB 01/92 12/02 9: Capaciy uilizaion 177 FRB 01/92 12/02 9: Personal income 192 BEA 01/92 12/ :00/8: Consumer credi 178 FRB 01/92 12/02 15: Consumpion 10 New home sales 167 BC 01/92 12/02 10: Personal consumpion expendiures 192 BEA 01/92 12/ :00/8: Invesmen 12 Durable goods orders 237 BC 01/92 12/ :30/9:00/10: Facory orders 178 BC 01/92 12/ : Consrucion spending 177 BC 01/92 12/ : Business invenories 177 BC 01/92 12/02 10:00/8: Governmen purchases 16 Governmen budge 175 FMS 01/92 12/ : Ne expors 17 Trade balance 192 BEA 01/92 12/02 8: Prices 18 Producer price index 193 BLS 01/92 12/02 8: Consumer price index 275 BLS 01/92 12/02 8: Forward-looking 20 Consumer confidence index 138 CB 01/92 12/02 10: NAPM index 156 NAPM 01/92 12/02 10: Housing sars 269 BC 01/92 12/02 8: Index of leading indicaors 275 CB 01/92 12/02 8: Six-week announcemens FOMC 24 Targe federal funds rae 175 FRB 01/92 12/02 14: Weekly announcemens 25 Iniial unemploymen claims 600 ETA 01/92 12/02 8:

11 Auhor's personal copy T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) sronges in he U.S., bu many of he U.S. macroeconomic fundamenals also significanly impac he foreign bond markes, and in he same direcion. This is, of course, consisen wih basic heoreical predicions. I is noeworhy ha, almos invariably, only he simulaneous effec is significan, reflecing a very quick price discovery process. The near insananeous response holds rue for all markes. Any sysemaic effec is almos exclusively resriced o he five-minue inerval following he news release. This helps explain why previous sudies relying on daily, or coarser, observaions ypically have failed o uncover sysemaic links beween asse marke reurns and innovaions o macroeconomic fundamenals he responses occur almos insananeously and end o drown in he overall day-oday price movemens. Hence, he only way o assess he connecion beween he news releases and he asse prices wih some degree of precision is o focus on he high-frequency reurns jus around he announcemen ime. The findings for he equiy markes are sriking. The full-sample resuls in Fig. 1A reveal almos no significan responses, bu once we spli he sample ino he expansion and conracion periods, we see ha posiive real economic shocks are me wih a negaive response in expansions and a posiive response in conracions. As discussed previously, his paern, which is idenical for he domesic and foreign markes, is suggesive of posiively correlaed real economic shocks across he regions along wih pronounced business cycle variaion in he imporance of he discoun facor versus cash flow componens in he markes' valuaion of equiies. This is furher corroboraed by he asymmeric effec of he PPI shocks over he business cycle. The marked negaive impac of inflaion surprises during expansions suggess Noes o Table 4 We pariion he U.S. monhly news announcemens ino seven groups: real aciviy, GDP consiuens (consumpion, invesmen, governmen purchases and ne expors), prices, and forward-looking. Wihin each group, we lis U.S. news announcemens in chronological order of heir release. 1 Toal number of observaions in our announcemens and expecaions daa sample. 2 Bureau of Labor Saisics (BLS), Bureau of he Census (BC), Bureau of Economic Analysis (BEA), Federal Reserve Board (FRB), Naional Associaion of Purchasing Managers (NAPM), Conference Board (CB), Financial Managemen Office (FMO), Employmen and Training Adminisraion (ETA). 3 Saring and ending daes of our announcemens and expecaions daa sample. 4 Easern Sandard Time. Dayligh savings ime sars on he firs Sunday of April and ends on he las Sunday of Ocober. 5 Sandard deviaion of he macroeconomic news surprise before we sandardize i. 6 10/98 is a missing observaion. 7 11/95, 2/96 and 03/97 are missing observaions. 8 In 01/94, he personal income announcemen ime moved from 10:00 EST o 8:30 EST. 9 Beginning in 01/96, consumer credi was released regularly a 15:00 EST. Prior o his dae he release imes varied /95 and 2/96 are missing observaions. 11 In 12/93, he personal consumpion expendiures announcemen ime moved from 10:00 EST o 8:30 EST /96 is a missing observaion. 13 Whenever GDP is released on he same day as durable goods orders, he durable goods orders announcemen is moved o 10:00 EST. On 07/96 he durable goods orders announcemen was released a 9:00 EST /98 is a missing observaion /96 is a missing observaion. 16 In 01/97, he business invenory announcemen was moved from 10:00 EST o 8:30 EST /88, 06/88, 11/98, 12/89 and 01/96 are missing observaions. 18 Beginning in 3/28/94, he fed funds rae was released regularly a 14:15 EST. Prior o his dae he release imes varied.

12 Auhor's personal copy 262 T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) Fig. 1. Noes o Fig. 1A, B and C: we graph he news announcemen response coefficiens from he weighed leas squares esimaion of Eq. (4.2), corresponding o he responses a he announcemen ime, and five, en, and fifeen minues afer he announcemen. We also show heeroskedasiciy consisen wo sandard error bands under he null hypohesis of a zero response. The common full sample spans July 1, 1998 o December 31, 2002, he expansion sample spans July 1, 1998 o February 28, 2001, and he conracion sample covers he period from March 1, 2001 o December 31, 2002.

13 Auhor's personal copy T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) Fig. 1 (coninued). he presence of sronger ani-inflaionary moneary policies, in urn srenghening he influence of he discoun facor componen in good economic imes. Finally, urning o he foreign exchange markes, news abou he U.S. inflaion rae does no seem o sysemaically affec he foreign exchange raes, while posiive domesic real shocks lead o an appreciaion of he Dollar, paricularly during he recen conracion regime.

14 Auhor's personal copy 264 T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) Fig. 1 (coninued) A closer look a sock bond correlaions The apparen sae dependence in he equiy markes news reacion funcion coupled wih he ime-invarian reacion of he bond markes naurally ranslaes ino sae dependen sock bond marke correlaions, wih price changes being posiively correlaed during

15 Auhor's personal copy T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) Fig. 1 (coninued). expansions and negaively correlaed during conracions. Indeed, he uncondiional sample correlaions for he expansion and conracion periods discussed in Table 3 already poin o he exisence of ime-varying cross-marke dependence. In order o explore his effec in more deail, we display in Fig. 2A he daily realized correlaions in each counry compued from he high-frequency sock bond marke reurns for he

16 Auhor's personal copy 266 T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) Fig. 1 (coninued). days conaining he arguably mos imporan U.S. macroeconomic announcemen, namely he nonfarm payroll employmen release. 13 Fig. 2B depics he corresponding realized correlaions over he enire monh, which aids assessmen of wheher he 13 The nonfarm payroll is among he mos significan of he announcemens for all of he markes, and i is ofen referred o as he king of announcemens by marke paricipans; see, e.g., Andersen and Bollerslev (1998).

17 Auhor's personal copy T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) Fig. 1 (coninued). correlaion paerns are driven by he macroeconomic news releases or wheher hey simply indicae he general relaionship among he markes. The compuaions follow he mehodology described in Andersen, Bollerslev, Diebold and Labys (2001, 2003a). To faciliae cross counry comparisons, we resric he calculaions o encompass he common rading hours from 8:20 o 12:30 EST, resuling in a oal of 51 five-minue inervals

18 Auhor's personal copy 268 T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) Fig. 1 (coninued). per day and approximaely 51 22=1122 five-minue observaions per monh. Specifically, we define corr h;h V d u P J j¼1 X J j¼1 R h d 1þj=J Rh V d 1þj=J 2 R h P J d 1þj=J j¼1! 1=2 ; 2 ð3:3þ R h d 1þj=J V

19 Auhor's personal copy T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) Fig. 1 (coninued). where J =51 (J 1122) for he daily (monhly) correlaions, and d refers o he corresponding daily (monhly) index. 14 Turning o he wo figures, he ime varying sock bond correlaions are remarkably similar across counries, no only for he nonfarm payroll announcemen daes (Fig. 2A), bu also when 14 We also ried adjusing for non-synchronous rading effecs by including up o hree addiional leads and lags in a Newey Wes calculaion of he correlaions, and he resuls were qualiaively idenical.

20 Auhor's personal copy 270 T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) Fig. 1 (coninued). calculaed for he full monh (Fig. 2B). The correlaions are generally higher and mosly posiive during he expansion period and smaller and negaive during he conracion period. Ineresingly, here is also an indicaion ha he correlaions may evolve smoohly, shifing raher slowly from values ypical of expansion o hose ypical of conracion. Moreover, here is a noiceable drop jus around Augus and Sepember of 1998, which corresponds o he Russian deb defaul crises and he Long Term Capial Managemen (LTCM) hedge fund collapse, a which ime he Federal Reserve acively inervened o avoid spillovers ino he

21 Auhor's personal copy T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) Fig. 2. Noes o Fig. 2A: we graph he daily U.S., Briish and German sock-bond realized correlaions, as deailed in he main ex, for nonfarm payroll announcemen days from January 1, 1992 hrough December 31, The shaded area corresponds o he U.S. conracion sample from March 1, 2001 o December 31, Noes o Fig. 2B: we graph he monhly U.S., Briish and German sock-bond realized correlaions, as deailed in he main ex, from January 1, 1992 hrough December 31, The shaded area corresponds o he U.S. conracion sample from March 1, 2001 o December 31, 2002.

22 Auhor's personal copy 272 T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) global capial markes. This episode is well known o have increased credi spreads on risky securiies worldwide. The burs of uncerainy regarding he financial and economic healh of he inernaional economy is clearly refleced in our correlaion measures as hey ake on a paern oherwise only observed during he conracion. Our European series are somewha conaminaed by his even as hey only are observed from July, 1998 onward. Ignoring he immediae afermah of he financial crisis in lae 1998, he swich in he sign of he correlaions maches almos perfecly he previously exogenously imposed U.S. business cycle regime. Our analysis is, of course, limied o he relaively shor calendar ime span and single U.S. expansion conracion period covered by he high-frequency daa. 15 Noneheless, i is noeworhy ha even hough he German and Briish's business cycles do no necessarily coincide wih he U.S. business cycle, i appears as hough he relevan sae variable for deermining he ime-varying impac of he news announcemens is he sae of he U.S. economy raher han he foreign counry. 16 Indeed, he paerns in he ime-varying correlaions are enirely consisen wih our previous asserion ha he discoun rae effec dominaes in each of he hree sock markes during U.S. economic expansions, coupled wih he U.S. ineres rae playing he role of he world ineres rae and hence dicaing he move of he foreign bond markes A generalized specificaion We have argued ha he movemens in asse reurns across markes and counries documened above are driven by he common exposure o exogenous U.S. macroeconomic shocks and he U.S. business cycle. This conrass wih previous sudies ha also documen imporan spillover effecs and marke linkages, bu lile (if any) role for macroeconomic fundamenals in explaining he comovemens beween markes. Our posiive resuls can be aribued o our focus on synchronous high-frequency daa around he ime of he announcemen all asses are acively raded during announcemen imes, so we observe he immediae news reacion of all asses which miigaes oher influences and poenially imporan omied variables biases. To furher invesigae he exen of he cross-marke and cross-counry links in he highfrequency daa, beyond he direc influence of he macroeconomic news announcemen effecs, i is informaive o consider he simulaneous equaions model, R h ¼ b h 0 þ X h Vph ¼ 1; N ; T: h0 Rh V þ XH i þ XK X J b h kj S k; j þ g h ; ð4:1þ Excep for he inclusion of he conemporaneous asse reurns on he righ-hand side, he model is idenical o our basic model (3.1). As in Eq. (3.1), he β h k0 coefficiens direcly capure he U.S. h macroeconomic announcemen effecs, while he β h0 accoun for any conemporaneous crossasse linkages and/or spillover effecs ha are no explained by he news announcemens. This 15 Using daily dae over a much longer ime span, Connolly, Sivers and Sun (2005) find ha U.S. sock-bond reurn correlaions are inversely relaed o he level of aggregae sock marke volailiy as measured by he VIX index. The VIX may in urn be inerpreed as a sae variable relaed o he level of economic uncerainy and he sage of he business cycle in he sense of David and Veronesi (2004) and Ribeiro and Veronesi (2002). See also he recen relaed empirical resuls in Guidolin and Timmermann (2005, 2006). 16 The U.K. did no experience a conracion from March 2001 o December The dominance of he U.S. ineress rae is consisen wih he recen empirical evidence repored in Chinn and Frankel (2004).

23 Auhor's personal copy T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) could include reacion o oher fundamenal informaion as well as non-fundamenal marke microsrucure, conagion, and cross-hedging effecs. The problem from an economeric perspecive is ha, wihou any addiional resricions or modeling assumpions, he conemporaneous coefficiens in β h h0 are no idenified. To overcome his problem, we follow he approach of a recen series of papers by Rigobon (2003), Rigobon and Sack (2003a,b, 2004), and Senana and Fiorenini (2001), who use he condiional heeroskedasiciy in he high-frequency daa o idenify he conemporaneous response coefficiens. The idea is sraighforward. Assuming ha he innovaions in Eq. (4.1) are condiionally uncorrelaed bu heeroskedasic as indicaed by our previous esimaion resuls for Eq. (3.2) he condiional covariances of he implied (3.1) innovaions will hen move in proporion o he condiional heeroskedasiciy in he (4.1) innovaions, wih he facors of proporionaliy deermined by β h h0 This proporionaliy in urn, allows for he idenificaion and esimaion of he conemporaneous response coefficiens. 18 Our approach follows Rigobon and Sack (2003b), in esimaing he elemens of β h h0 by applying Gaussian quasi-maximum likelihood esimaion (QMLE) echniques o he mulivariae GARCH model implied by univariae GARCH models for each of he individual equaions in (4.1). 19 To faciliae he implemenaion of he mulivariae GARCH model, we rea he residuals from he firs-sage esimaion of (3.1) as direcly observable. Also, for racabiliy, we esimae he model for hree markes a a ime, bu he same idea could in principle be applied o any number of asses. Focusing firs on he rivariae domesic sysem consising of U.S. T-Bond, S&P500, and $/ Euro reurns, we obain he following esimaes for he conemporaneous linkages among he hree markes based on he 9301 five-minue announcemen period reurns spanning he July 1, 1998 hrough February 28, 2001 expansion ime period: R TBond R S&P R $=Euro ¼ 0:026R S&P ð 9:41Þ þ XK X J ¼ 0:204R TBond ð25:33þ þ XK X J ¼ 0:030R TBond ð12:53þ þ XK X J þ 0:020R $=Euro ð3:34þ b h kj S k; j þ g h þ 0:120R $=Euro ð14:88þ b h kj S k; j þ g h 0:002R S&P ð 2:39Þ b h kj S k; j þ g h ; þb h 0 þ XH þb h 0 þxh þb h 0 þ XH i i i ð4:2þ ð4:3þ ð4:4þ 18 Formally, consider he marix represenaion of (4.1), ΨR =ΦX 1 +η, where he η h are heeroskedasic bu serially and conemporaneously uncorrelaed. The corresponding (3.1) represenaion, R =Ψ 1 ΦX 1 +Ψ 1 η, hen uniquely deermines he disribuional properies of R. Imporanly, he non-zero off-diagonal elemens of he ime-varying condiional covariance marix for he (3.1) shocks, ε Ψ 1 η, depend direcly on Ψ 1, hus enabling idenificaion of Ψ. 19 To economize on he number of parameers, we include only hose macroeconomic news announcemen dummies ha were saisically significan a he five-percen level in he esimaion of Eq. (4.1). We also employ a more parsimonious GARCH(1,1) specificaion, E 1 ½ðg h Þ2 Šuðr h Þ2 ¼ x h þ b h ðr h 1 Þ2 þ k h ðg h 1 Þ2 þ P K g h;kd k;, as opposed o he ARCH (9) model implici in Eq. (4.1).

24 Auhor's personal copy 274 T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) where he numbers in parenheses refer o robus -saisics. 20 A number of he coefficiens are highly significan and hey all have a naural inerpreaion. For example, an increase in sock prices may be seen as a signal of a posiive real aciviy or inflaionary shock and he poin esimae for he S&P500 reurn coefficien in Eq. (4.2) is enirely consisen wih he implicaions of he sylized moneary model. The impac of he exchange rae reurns is clearly less imporan, bu he sign is compaible wih exchange rae changes on balance reflecing real economic shocks. Eq. (4.3) is also direcly in line wih our aforemenioned discussion of he dominance of he discoun facor componen in he evaluaion of sock prices during economic expansions, whereby higher bond prices (lower discoun raes) are good for he sock marke in good imes. Similarly, dollar depreciaion (inerpreed as a negaive real aciviy or deflaionary shock) resuls in higher sock prices. Noice also ha while he uncondiional correlaion beween bond and sock prices for he expansion period repored in Table 3 is posiive, he esimaion mehod underlying Eqs. (4.2) (4.4) allows us o disenangle wo opposing effecs: bond prices affec sock prices posiively, bu sock prices affec bond prices negaively. 21 Finally, inerpreing negaive bond reurns and posiive sock reurns as indicaors of real economic srengh he associaed appreciaion of he Dollar implied by Eq. (4.4) is as expeced. Esimaing he same se of equaions for he 6463 five-minue announcemen period reurns over he March 1, 2001 hrough December 31, 2002 conracion ime period produces he following resuls: R TBond R S&P R $=Euro ¼ 0:033R S&P ð 6:26Þ þ XK X J ¼ 0:192R TBond ð 3:88Þ þ XK X J ¼ 0:033R TBond ð2:70þ þ XK X J þ 0:010R $=Euro ð0:47þ b h kj S k; j þ g h 0:090R $=Euro ð 1:97Þ b h kj S k; j þ g h 0:011R S&P ð 4:28Þ b h kj S k; j þ g h : þb h 0 þ XH þb h 0 þ XH þb h 0 þ XH i i i ð4:5þ ð4:6þ ð4:7þ The esimaes for Eqs. (4.5) and (4.7) are qualiaively as before, alhough he linkages among he ineres rae and he oher variables appear o have declined. This is consisen wih he ineres raes being less sensiive o economic shocks during he conracion. In conras, he difference in he esimaes for he S&P500 reurns in Eqs. (4.3) and (4.6) is sriking. The conemporaneous linkages beween he sock marke and he oher markes flips sign beween he wo periods. As 20 The repored -saisics do no formally accoun for he firs-sage condiional mean parameer esimaion error, bu his effec is almos surely negligible in he presen conex. 21 Our resuls for he high-frequency daa in Eqs. (4.2) and (4.3) agree wih he findings repored in Rigobon and Sack (2003b) based on daily sock and bond marke reurns from November 1985 o March Of course, his is predominanly an expansionary period, so i is no surprising ha he direcional effecs coincide.

25 Auhor's personal copy T.G. Andersen e al. / Journal of Inernaional Economics 73 (2007) before, good news during expansions is bad news for socks, bu good news during conracions is good for he sock marke. In summary, he dominan finding is ha posiive sock reurns (posiive real or inflaionary shocks), ceeris paribus, always raise ineres raes, while posiive innovaions o ineres raes (real or inflaionary shocks) have a srongly regimedependen impac on sock reurns, once again confirming he differenial impacs of he cashflow and he discoun rae effecs over he business cycle. Finally, we use he same approach o esimae he inerdependence among he naional sock markes beyond he linkages explained by he U.S. macroeconomic announcemens. As before, dividing he sample in wo, we find for he expansion sample: R S&P R FTSE R DJE ¼ 0:028R FTSE ð5:83þ þ XK X J ¼ 0:014R S&P ð2:73þ þ XK X J ¼ 0:089R S&P ð13:26þ þ XK X J þ 0:007R DJE ð2:00þ b h kj S k; j þ g h þ 0:015R DJE ð9:57þ b h kj S k; j þ g h þ 0:001R FTSE ð0:23þ b h kj S k; j þ g h : þb h 0 þ XH þb h 0 þ XH þb h 0 þ XH i i i ð4:8þ ð4:9þ ð4:10þ No surprisingly, all esimaed coefficiens are posiive, indicaing imporan cross-counry linkages over-and-above hose explained by he U.S. macroeconomic news releases. I is unclear wheher hese high-frequency inernaional marke linkages are due o common reacions o worldwide fundamenal news or reflec cross-marke hedging or oher non-fundamenal conagion effecs. Esimaing he same relaions over he more recen conracion period suggess even sronger conemporaneous cross-counry linkages: R S&P R FTSE R DJE ¼ 0:447R FTSE ð17:80þ þ XK X J ¼ 0:074R S&P ð11:44þ þ XK X J ¼ 0:073R S&P ð10:49þ þ XK X J þ 0:210R DJE ð14:98þ b h kj S k; j þ g h þ 0:085R DJE ð9:88þ b h kj S k; j þ g h þ 0:115R FTSE ð8:74þ b h kj S k; j þ g h : þb h 0 þ XH þb h 0 þ XH þb h 0 þ XH i i i ð4:11þ ð4:12þ ð4:13þ