Stock Return Skewness and the Cross Section of Monetary Policy Announcement Premiums

We find that the FOMC-announcement-day return premium earned by a firm is positively related to the increase in its ex ante, option-implied skewness prior to the announcement. This finding is consistent with: (1) the existence of an announcement-day Fed put that is partially anticipated by the financial market; (2) the pre-announcement increase in a firm’s option-implied skewness being a proxy for its Fed put exposure (FPE); and (3) FPE commanding a positive price of risk. High (low) FPE firms are those firms whose preannouncement increase in option-implied skewness is the largest (smallest). We find that high (low) FPE firms indeed experience a larger (smaller) increase in their realized skewness and 5% conditional value at risk (CVaR) on announcement days. Using aggregate implied skewness measured right after the FOMC announcement as a proxy for the strength of the realized announcement-day Fed put, we verify that the announcement-day returns of high FPE firms indeed exhibit greater sensitivities to the Fed put. We also find that the announcement premium earned by high relative to low FPE firms tend to increase when the level of VIX is high or when one-month-lagged market return is low, consistent with the Fed put being more valuable to market participants during these times