Can trading on federal funds rate change announcements produce above normal stock market returns?: A test of market efficiency

Document Type

Article

Publication Date

2008

Abstract

Efficient market theory contends that investors are unable to make an above normal return by trading on public information. Can an investor earn an economic profit in the stock market by trading on the basis of Federal Reserve (Fed) rate change announcements? The purpose of this study is to determine whether the announcement of a federal funds rate target change affects stock prices in the short run (5 to 30 days after the announcement). Over the period 1988 to 2007 results show a statistically significant negative correlation between target federal funds rate changes and the S&P 500 index in the short run. Regression results suggest that changes in the federal funds rate target appear to stimulate opposite changes in the 5-day, 10-day, and 30-day post announcement returns. Evidence shows that the strategy of purchasing the S&P 500 market index on the announcement of a federal funds target rate cut can yield 5-day, 10-day, and 30-day post announcement excess returns. Results also confirm that negative correlation between target federal funds rate changes and the S&P 500 index significantly decreased as periods of time following a rate change increased. This study suggests that the market is not efficient with respect to announcements of Federal Funds rate changes in the short term.

Original Citation

Weinstein, E., Bacon, F. W. (2008). Can trading on Federal Funds Rate change announcements produce above normal stock market returns? A test of market efficiency. Academy of Accounting and Financial Studies Proceedings of the Allied Academies International/Jordan Whitney Enterprises, 12(2), 121-129. https://www.proquest.com/openview/a70ff969677e187ea6f593b8abff6c30/1?pq-origsite=gscholar&cbl=29414

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