Fed-Driven Systemic Tail Risk: High-Frequency Measurement, Evidence and Implications

RePEc Short ID: pne3
ORCID iD: 0000-0003-2852-9419

Erdemlioglu, Deniz; Neely, Christopher J.; Yang, Xiye

doi:10.20955/wp.2023.016

Working Paper Revision

Fed-Driven Systemic Tail Risk: High-Frequency Measurement, Evidence and Implications

Abstract: We develop a framework to measure market-wide (systemic) tail risk in the cross-section of asset returns. Using high-frequency data on individual U.S. stocks and sector-specific ETF portfolios, we estimate time-varying jump intensities and multi-asset tail risk around Fed policy announcements. While most FOMC announcements generate systemic left-tail risk, there is no evidence that macro announcements have a similar effect. The magnitude of the tail risk induced by Fed policy announcements varies over the business cycle, peaks during the global financial crisis and remains high during phases of unconventional monetary policy. We use our approach to construct a Fed-driven systemic tail risk (STR) indicator. STR helps explain the pre-FOMC announcement drift and significantly increases variance risk premia, particularly for the meetings without press conferences. Our measure complements existing option-based tail risk measures in identifying tail events.

JEL Classification: C12; C14; C22; C32; C58; G12; G14;

https://doi.org/10.20955/wp.2023.016