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Dr. Alex Castaldo

Review:  The Stock Market's Reaction to Unemployment News by J.H. Boyd, J. Hu and R. Jagannathan Journal of Finance, April 2005, p 649.

The unemployment rate is announced once a month, usually at 8:30 on a Friday. This paper covers all announcements from February 1957 to December 2000.

As is standard in academic studies, "news" is defined as the difference between the actual number released and what an econometric model would have predicted. "Good news" on unemployment [U-good-news] means the unemployment rate turned out lower than the statistically estimated equation was forecasting. [because of revisions and lags in data availability it is somewhat problematic whether the forecast really is one "could have been made" at the time of the announcement; nevertheless the authors claim to have come up with an equation that is realistic in this sense. The authors also claim to have selected their model using only data prior to January 1962].

The equation for forecasting the unemployment rate is based on changes in Industrial Production, on lagged Unemployment rate change, on 3 month Trasury bills and the credit spread between Baa and Aaa bonds.

The main finding is that the response of the S&P500 on the announcement day depends on the state of the economy (NBER expansion or contraction) at the time:

U-good-news U-bad-news NBER Expansion 0.0316% 0.2648% NBER Contraction 0.1978% -0.1286%

(the standard deviation is a smidgeon over 1%)

Basically during an expansion the stock market is happy with a bad unemployment number, while during a recesion it prefers a good unemployment number.

The authors are aware that the NBER classification is not available in real time. At best investors only know the probability that the economy is in a recession at the present time, not the final NBER verdict. Even with such a looser concept of recession, the authors are able to show that an asymmetry in response exists.

The results are descriptive, and cannot be used to earn a profit. But they are interesting. As the authors conclude "the nature of stock price response to unemployment news indicates market expectations regarding whether the economy is in a contraction or expansion".

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