The Risky Fed Put and the Cross Section of FOMC Announcement Premia

By comparing the implied skewness of options that cover a scheduled FOMC announcement with options of the same duration but expire shortly before the announcement, we find that investors anticipate monetary policy to increase the skewness of equity returns—with the increase being driven by the left tail. Referring to this reduction in downside risks as the “Announcement-day
Fed Put” (AFP) and firms’ exposure to the AFP as their “Fed Put exposure” (FPE), we find that FPE is priced. High FPE firms earn a larger announcement-day return premium than low FPE firms, and the high-minus-low premium increases with monetary policy uncertainty (MPU). These results suggest that, even though the AFP reduces tail risks, the extent to which it can do so is uncertain and viewed as a source of risk by market participants.

In support of funding liquidity being a channel through which monetary policy reduces tail risks, we find that high FPE firms are more exposed than low FPE firms to the capital shocks faced by New York Fed’s primary dealer counterparties. This exposure is especially pronounced with respect to positive shocks—i.e., enhanced funding liquidity—consistent with the AFP capturing a
“put-option-like” component of monetary policy and high FPE firms being more exposed to this component.