Thursday, May 05, 2016

ECB study calls for tighter controls on release of market-moving news

By John Filar Atwood

A European Central Bank (ECB) study on the movement of stock index and Treasury futures markets around the release of U.S. macroeconomic news has found evidence of substantial informed trading before the official release time. As a result, the ECB said that strict release procedures should be implemented for all market-moving announcements, including announcements originating in the private sector.

The working paper examined the prevalence of pre-announcement price drift in U.S. stock and bond markets and looked for possible explanations. The authors found that seven out of 21 market-moving announcements show evidence of substantial informed trading before the official release time.

According to the paper, prices begin to move in the “correct” direction about 30 minutes before the release time, and the pre-announcement price drift accounts on average for about half of the total price adjustment. The authors defined the “correct” direction as movement in the direction of the price change consistent with the announcement surprise.

Private information. The authors concluded that the results imply that some traders have private information about macroeconomic fundamentals. In addition, they believe the preannouncement drift likely comes from a combination of information leakage and superior forecasting based on proprietary data collection and reprocessing of public information.

The paper also concluded that the total impact of macroeconomic news is larger than measured in most event studies, which ignore the pre-release price drift. Consequently, the authors believe that the total impact of macroeconomic news on financial markets is larger, and financial markets are linked more tightly to the real economy, than usually found.

Study mechanics. The authors studied the impact of announcements on second-by-second E-mini S&P 500 stock index and 10-year Treasury note futures from January 2008 to March 2014. The study was based on 21 market-moving announcements among a sample of 30 U.S. macroeconomic announcements. According to the paper, 11 of the 21 announcements exhibited some pre-announcement price drift, and for seven of the announcements the drift was substantial.

The authors found that extending the sample period back to 2003 with minute-by-minute data revealed both a higher announcement impact and a stronger pre-announcement drift since 2008, particularly in the S&P E-mini futures market. They estimated that since 2008 in the S&P E-mini futures market alone the profits associated with trading prior to the official announcement release time have amounted to about $20 million per year.

Pre-release drift. The paper stated that the difficulty in identifying the causes of pre-announcement drift stems from the relatively small number of announcements that actually move financial markets. However, the authors still found that an implementation of strict release procedures makes pre-release drift less likely. They said that this applies in particular to data released under the Principal Federal Economic Indicator guidelines, which impose strict security procedures.

The authors noted that public information, such as internet activity data, predicted the surprise in a few cases where the public information closely corresponded to the forecasting target. Similarly, improvements in data processing render privately collecting large amounts of comparable information feasible, which can be used for generating proprietary forecasts ahead of time, they stated.