Working Paper

Intermeeting Rate Cuts as a Response to Rare Disasters

Abstract: This paper measures the probability of rare disasters by measuring the probability of the intermeeting federal funds rate cuts they provoke. Differentiating between months with Federal Open Market Committee (FOMC) meetings and months without identifies excess returns on federal funds futures averaging -1.5 bps per horizon month-ahead at short horizons, corresponding to a 3-5% per month risk-neutral probability of an intermeeting rate cut. The excess returns differ between months with and without meetings, suggesting a positive risk premium associated with meetings. The federal funds excess returns explain a significant portion of equity excess returns, and hence the equity premium puzzle.

Keywords: Rare disasters; Equity premium; Risk premium; Federal funds futures; ;

JEL Classification: E44; G12;

https://doi.org/10.17016/FEDS.2020.076

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2020-08-28

Number: 2020-076