Abstract
AbstractRecent evidence shows that monetary policy announcements convey significant information about expected market returns and are therefore good candidates for innovations in intertemporal asset pricing state variables. I propose an asset pricing model with the market return and a mimicking portfolio for unexpected changes in the federal funds rate on days of Federal Open Market Committee announcements. This economically motivated two‐factor model prices portfolios formed on size, value, momentum, investment, and profitability with an R2 of 80% and an average annual pricing error of 0.93%, performing as well as standard four‐, five‐, and six‐factor models designed to price these assets.
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