Essays on Macroeconomic Policy and the Prices of Financial Assets
Creators: name: Caldera, James
Publisher: name: My University
Year: 2022
Subjects: subject: Capital market prices
subject: Macroeconomic policy
subject: Too big to fail
subject: Life insurance
subject: Pre-FOMC announcement drift
subject: Finance
subject: Business and Economics

description: My dissertation investigates what information embedded in financial prices reveals about questions relevant for macroeconomic policy. The first two chapters examine implicit government guarantees in the U.S. life insurance industry. My third chapter provides novel evidence on a phenomenon at the intersection of asset pricing and monetary policy. To what extent do investors view life insurers as “too big to fail?” Chapter 1 provides new evidence on this question using a natural experiment from the 2008-09 financial crisis. The analysis examines market reactions to a U.S. Treasury announcement that raised expectations about government backstops for the life insurance industry. I find that a subset of large life insurers benefited from significant protection against bankruptcy, with implied risk neutral probabilities of a government rescue ranging from 21% to 37% at the one-year horizon. Rescue probabilities exhibit a broadly downward sloping term structure, suggesting that investors expected the protection to subside with time. Cross-sectional differences are also informative about which insurers would later be designated systemically important by regulators. Chapter 2 builds on the findings presented in Chapter 1. In this chapter, I study the long-term dynamics of implicit government backstops for the U.S. life insurance industry and how this protection affects moral hazard. I structurally estimate a partial equilibrium model of life insurers protected in part by emergency bailouts. The estimates imply that for the 2001-20 period the investor expectation of the (physical) probability of a bailout is 9.1% for large insurers. Indicative of prominent time-variation, the standard deviation of these bailout probabilities is 10.3%. A counterfactual analysis reveals limited average levels of moral hazard in risk-taking practices. Structural estimates for small life insurers imply more modest support. Overall, the results are consistent with the presence of a significant and time-varying “too big to fail” subsidy for large life insurers. In Chapter 3, I investigate a puzzle of asset pricing in relation to monetary policy communication. S&amp;P 500 stocks earn extraordinary returns in the run-up to Federal Open Market Committee (FOMC) announcements. Recent literature documents that this pre-FOMC drift appears to have waned after early 2011. Using data extended through 2020, I show that pre-announcement returns have since rebounded in the most current period. What do these fluctuations reveal about the impetus behind this phenomenon? This chapter addresses this question with options-based methodology that disentangles variation in FOMC policy impact from investor anticipation thereof. I decompose close-to-announcement returns into risk premia, price changes that reflect information about the announcement, and an unexplained (anomalous) component. I find that 30% to 55% of average pre-FOMC returns between 1996 and 2011 were due to an anomaly that has since vanished. During this time, risk premia account for 32% to 77% of this mean whereas informed trading in advance of positive news represents only between 1% and 12%. The cessation of anomalous returns and changes in risk premia appear most responsible for recent shifts in pre-FOMC returns. With findings that are informative for macroprudential policy, the contributions of my first two chapters shed new light on the “too big to fail” problem in the insurance sector. My investigation of the pre-FOMC announcement drift in Chapter 3 further elucidates how capital markets are influenced by monetary policy decisions. The evidence I present highlights the usefulness of financial prices for informing policy.