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Macroeconomic surprises and short-term behaviour in bond futures 271
They assume that this variable captures the intradaily seasonality and the news
effect that standard GARCH models are not able to capture. Finally, two papers focus
on the mean of the returns of the Treasury bond future and several exchange rates.
Andersen et al. (2003) analyse, in a seven year period, the forecasting errors of 40
fundamentals using a very similar approach to Andersen and Bollerslev (1998)
but for the mean. Hautsch and Hess (2002) use the revision unemployment re-
port numbers that include important variables such as the unemployment rate
and non-farms payrolls.
In this paper 1) the financial asset on which we base our analysis is the US
Treasury 10-year bond future, 2) we consider 15 fundamentals representing different
sectors of the economy (inflation, real economy, supply and demand confidence
indexes and export–import measures), 3) we are interested in the effect of
news announcements on the mean rather than on volatility, 4) we consider the
forecasting errors rather than the released numbers, 5) we differentiate between
positive and negative forecasting errors, 6) we assume that the effect of the
fundamentals on the bond market differs depending on the business cycle (top,
bottom, expansion and contraction), and 7) we use an econometric model that
estimates contemporaneous and ex-post effects of the macroeconomic news
smoothly, that is, the parameters that measure the news effect vary smoothly
through time.
One of the main features of the paper is the interaction between 5 and 6. That is,
we not only permit good and bad news to affect differently the bond future, but we also
investigate whether these effects are robust within the economic cycle. If there are
variations, we may conclude that market’s behaviour depends on the mood of the
economy or how the market perceives the state of the economy. This is related to
the work in behavioural economics and, in particular, behavioural finance. Since
the introduction of prospect theory (Kanehman and Tversky 1979), it is well known
that individuals suffer from an asymmetry between the way they make decisions
involving gains (good news) and decisions involving losses (bad news). This leads
to a failure of invariance, i.e. inconsistent choices (or reactions to good and bad
news) when the same problem (a good or a bad news item) appears in different
frames (top, bottom, expansion and contraction of the business cycle). An alternative
means of explaining why the market responds differently to good and bad
news in different phases of the business cycle is by means of uncertainty (Veronesi
1999): The market is uncertain about the state of the economy. For example, after a
period of economic boom, good news will have no effect as traders are already
aware of the strength of the economy. If, by contrast, bad news start to arrive, the
market reacts because it is not no longer confident about the phase of the business
cycle. This introduces more uncertainty and causes an asymmetry in the response
to good and bad news. On this basis, Conrad et al. (2002) test this asymmetric
reaction to the news sign and the state of the stock market (the equivalent to the
business cycle in our paper). In a firm-specific study, and using earnings announcements,
they conclude that price responses to negative earnings surprises
increase as the difference between the market value at the moment of the announcement
and the average market value during the last 12 months, increases. In
other words, the effect of a negative earnings surprise is higher if the market feels
itself to be in expansion with respect to the previous 12 months, than in contraction.
Or, put differently, markets respond more strongly to bad news in good times. By