Market Response to Macroeconomic Announcements under Optimal Attention Allocation: Theory and Evidence

Abstract

I develop a model of investor behavior around prescheduled macroeconomic announcements. My model analyzes the optimal allocation of investor attention between systematic and idiosyncratic risk factors when a macroeconomic announcement is anticipated. Skilled investors, when producing information under a limited attention capacity, optimally allocate more of their attention to analyzing the idiosyncratic risk factor when they anticipate more precise public information about the systematic risk factor from the macroeconomic announcement. Consequently, my model predicts that, the more informative (precise) the macroeconomic announcement is expected to be about the underlying risk factors, ceteris paribus, the more uncertainty pre-announcement, the more resolution of uncertainty post-announcement, and the higher the trading volume around the announcement on the market index. My empirical analysis of trading by investors around both FOMC and CPI announcements support my model's predictions. In particular, my empirical findings are consistent with model predictions about the effect of the anticipated macroeconomic announcement precision on investor attention allocation, the effect of investor attention on the levels of pre-announcement and post-announcement trading volumes, and the effect of investor attention on the ratio of post-announcement trading volume over the pre-announcement trading volume.