The Federal Reserve’s interest rate decisions and monetary policy meetings have long been known to influence market dynamics, and a recent research paper sheds light on a compelling trading strategy associated with these events.
The study, “Flight to Lottery Ahead of FOMC Announcements,” published in the prestigious British Journal of Management, explores the intriguing phenomenon of trading low-valued stocks before Federal Open Market Committee (FOMC) announcements.
Authored by a team of renowned researchers, including Haifeng Guo, Chi-Hsiou D. Hung, Alexandros Kontonikas, and Yeqin Zeng, the research reveals compelling insights into the behavior of investors in the lead-up to FOMC announcements. It unveils a pattern of increased speculation and trading activity in stocks with high idiosyncratic skewness, commonly called “lottery-like stocks.”
The study’s core finding is that investors are drawn to lottery-like stocks in anticipation of FOMC announcements due to the perceived uncertainty and potential for high returns associated with these events. This heightened interest increased trading activity and a surge in trading volumes for such equities in the days leading up to FOMC declarations.
The research, which analysed data from 1994 to 2021 for U.S. stocks, demonstrates a significant outperformance of lottery shares compared to regular ones in the pre-FOMC window. Notably, this study excludes stocks priced below $1.
Furthermore, the study delves into the roles played by institutional and retail investors in the flight to lottery-like stocks. It reveals that institutional investors are more inclined to engage with such equities, leveraging their resources and expertise to capitalize on these opportunities.
In light of these findings, the authors emphasize the importance of central banks and business managers being mindful of this trading behavior. They suggest that central banks should acknowledge the potential for speculators to invest in lottery-style stocks before FOMC announcements. Businesses, in turn, must adapt and proactively address this shift in market behavior.
Saqib Iqbal, an analyst at Trading.Biz, commented on the research, stating, “The FOMC holds eight scheduled meetings per year, each presenting significant trading opportunities for equities managers and investors.
“However, the key to success lies in selecting the right stocks, and it’s worth noting that the research does not prescribe a specific trading methodology. Traders should thoroughly strategize before making any investment decisions.”
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