Fed Speak: A Market Microstructure Analysis

Abstract

Many authors have argued that increased transparency by central banks is likely to improve economic welfare by reducing information asymmetries in financial markets. Accordingly, central banks worldwide have taken steps to release more information related to their policy decisions. Extant empirical studies related to the effects of monetary policy typically examine the relationship between some policy metric and security returns. Such studies, however, do not adequately characterize information asymmetry, or other non-price effects on financial markets associated with central bank announcements. A more direct measure of information asymmetry is the bid-ask spread, especially the adverse selection component of the spread. If FOMC announcements create information asymmetries, then we can discern the sign and magnitude of the effect by analyzing liquidity measures during the announcement window relative to liquidity measures during an appropirate benchmark period. In addition, we use this analysis to assess whether the recent efforts by the FOMC to reduce information asymmetry have been effective.