Abstract

We document that on the two days following macroeconomic news announcements, the stock market has negative excess returns, and the security market line has a significantly negative slope. These findings concentrate on days after bad macroeconomic news, which indicates that the market does not fully incorporate negative macro shocks on the announcement day. The underreaction effect is stronger among stocks with higher information uncertainty, tighter short-selling constraints, and when intermediary capital is scarce, consistent with the theory of limits to arbitrage. Considering the underreaction effect, we argue that the risk premium on macroeconomic announcement days is lower than previously believed.

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