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Journal of Empirical Finance 7 2000 479–507 www.elsevier.comrlocatereconbase
Macroeconomic announcement effects on the covariance structure of government bond returns
Charlotte Christiansen
Department of Finance, The Aarhus School of Business, Fuglesangs Alle 4, DK-8210 Aarhus V, Denmark
Accepted 6 November 2000
Abstract
This paper concerns the effects of macroeconomic announcements on the covariance structure of US government bond returns for six different maturities; the study shows that
the conditional variances, covariances, and correlation coefficients are significantly greater on announcement days. On non-announcement days, the correlation coefficients are rela-
tively large and are greater the closer the bonds are with respect to the time to maturity. The maturity dependency is substantially dampened on announcement days and, hence, releases
of macroeconomic news induce common movement in the government bond market that strengthen the correlations. q 2000 Elsevier Science B.V. All rights reserved.
JEL classification: G12; C32 Keywords: Constant conditional correlations model; Covariance; Government bonds; Macroeconomic
announcements; Multivariate GARCH
1. Introduction
This paper assesses the impact of macroeconomic news releases on the U.S. government bond market. In particular, we study the effects that releases of the
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Employment Situation and the PPI Producer Price Index reports, published by the Bureau of Labor Statistics, have on the conditional covariance structure of
excess bond returns for six different maturities.
Tel.: q45-8948-6691; fax: q45-8615-1943. Ž
. E-mail address: chaasb.dk C. Christiansen .
0927-5398r00r - see front matter q 2000 Elsevier Science B.V. All rights reserved. Ž
. PII: S 0 9 2 7 - 5 3 9 8 0 0 0 0 0 2 3 - 2
Contrary to stocks and corporate bonds, there is hardly any asset-specific or private information regarding Treasury bonds. Instead, changes in government
bond returns depend on the arrival of public information, e.g. macroeconomic variables such as the inflation and the real interest rate, and the fiscal and
monetary policy conducted. Accordingly, macroeconomic announcements affect the Treasury bond market. It is well known that the return volatility of financial
assets, including bonds, are autocorrelated and highly persistent over time, for a
Ž .
review, cf. Bollerslev et al. 1992 . Hence, it has been suggested that the
announcements of macroeconomic news could explain the observed high degree of volatility persistence on the government bond market.
A number of empirical studies have been undertaken in the finance literature to examine the implications of macroeconomic announcements on the government
bond market in a wide range of setups. Below is a brief and, by no means, Ž
. exhaustive survey of this literature. Jones et al.
1998 study the effects of
announcements of employment and PPI figures on the conditional volatility of the excess returns of three different U.S. government bonds using daily data. The
conditional variance is assumed to evolve according to a univariate Generalized Ž
. Autoregressive Conditional Heteroscedasticity GARCH process, which is ex-
tended to include level as well as persistence differences on announcement and non-announcement days. The results show that announcement shocks are not
persistent and that the conditional variance is significantly higher on announce- ment days.
Ž .
Ž .
In a framework similar to Jones et al. 1998 , Li and Engle 1998 study the Ž
effects of macroeconomic announcements Consumer Price Index, PPI, and Em- .
ployment situation reports on the volatility of the U.S. Treasury bond futures. Using a univariate GARCH framework, they find that announcement shocks are
not persistent, that positive and negative announcement shocks are significantly different, and that persistence is stronger after bad news is released than after good
Ž .
news. Li and Engle 1998 do not discover significant increases in the returns on Ž
. announcement days i.e. there is no risk premium for macroeconomic news .
In a series of papers, Fleming and Remolona investigate macroeconomic Ž
announcement effects on the Treasury market. Fleming and Remolona 1997, .
1999a apply 1 year of intra daily data on the 5-year Treasury note and they find that the largest changes in price and trading volume stem from macroeconomic
announcements. Moreover, the most influential announcements are the employ- ment and the PPI reports. The unexpected component of the announcement is of
importance for the reaction of the bond market. Immediately after macroeconomic announcements, the bond price changes sharply and the trading volume declines.
Subsequently, there is a surge in trading activity and a high level of price volatility
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tends to persist. Using a longer sample, Fleming and Remolona 1999b estimate a homoscedastic affine model of yield changes using announcement surprises as
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Generalized Methods of Moments GMM instruments, which give rise to humped shaped yield curves.
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Balduzzi et al. 1997 investigate the impact of 27 different economic news announcements on the bond market using intra day data. In their paper, the
surprise components of macroeconomic announcements are considered, where expectations of the variables are taken from surveys of money market managers.
For price reactions of the 10-year Treasury note, the most important announcement
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is the Non-farm Payroll which is published in the Employment Situation report , and the second most important variable is the PPI figure. The paper shows that
trading volume and volatility are significantly higher following AimportantB economic announcements.
Ž .
Ederington and Lee 1993 explore the impacts of 19 different announcements on the futures markets of Treasury bonds. Amongst others, the employment figure
and PPI cause significant price changes. In addition, the paper concludes that the day-of-the-week effects are caused solely by the timing of macroeconomic news
releases.
To the author’s knowledge, so far, no methodical studies have examined the effects of macroeconomic announcements on the covariance structure of govern-
ment bond returns. Thus, the aim of this paper is to represent an improvement of Ž
. the univariate analysis of responses to risk i.e. releases of macroeconomic news ,
Ž .
which, according to Jones et al. 1998, p. 335 , is a potential limitation of the existing literature. In many fields of finance, is it paramount to apply a multivari-
ate model of the distribution of asset returns. These areas include risk manage- ment, asset allocation, and asset pricing. A number of examples will further
illustrate why it is interesting to study the implications of macroeconomic an- nouncements on the covariance structure of government bonds: A commercial
bank’s capital requirement is determined by its Value-at-Risk, which again is calculated using the covariance matrix of the assets in its portfolio. Hence,
macroeconomic announcement effects on the covariance structure of government bonds influence the capital requirements of a commercial bank holding govern-
ment bonds. Consider another example, namely the portfolio choice of an investor: The investor’s optimal portfolio composition depends on the covariance of the
assets in question. Thus, macroeconomic announcement effects on the covariance structure of government bonds might alter the optimal weights of the investor’s
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portfolio. Lastly, the value of a derivative contract e.g. a spread option with two Ž
. or more different government bonds as its underlying is altered by macroeco-
nomic announcement effects on the covariance structure of bond returns. A further reason why it is valuable to apply a multivariate framework in the
present analysis, is as follows.
1
Even though we do not explicitly consider zero-coupon bonds, our study of government bonds of different maturities is
essentially also a study of the term structure of interest rates. Consequently, by applying a multivariate model, we are able to draw conclusions with respect to the
1
This was kindly pointed out to me by an anonymous referee.
impact on the term structure of interest rates of macroeconomic announcements. Conveniently, the literature of the empirical properties of the term structure of
interest rates provides a basis for comparison, cf. e.g. Litterman and Scheinkman Ž
. Ž
. Ž
. 1991 , Chen and Scott 1993 , and Jeffrey 1998 . Moreover, this perspective
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links our work to Fleming and Remolona 1999b . Above, it is established that there is a strong relation between releases of
employment and PPI figures and the government bond market. These macroeco- Ž
. nomic announcements are released periodically monthly on pre-announced dates
and, hence, they are not clustered in time. Furthermore, the contents of the reports are instantaneously available to all market participants. Consequently, in the
following, we investigate the effect of these announcements in a heteroscedastic multivariate model of the excess returns of six government bonds with different
maturities. More specifically, by extending the Constant Conditional Correlations Ž
. Ž
. CCORR
model of Bollerslev 1990
to include announcement effects, we document that the conditional variances, covariances, and correlations of bond
excess returns are significantly larger on macroeconomic announcement days. The excess returns of the government bond market are strongly correlated and the
correlation is stronger the closer the bonds are with respect to the time to maturity. The maturity dependency is substantially dampened on announcement days, which
implies that releases of macroeconomic news induce common movements in the government bond market. The rise on macroeconomic announcement days in the
conditional covariance of two government bonds is of economic importance and is an decreasing function of the time to maturity of either of the bonds. Similarly, the
addition to the conditional variance on macroeconomic announcement days is substantial and is a decreasing function of the time to maturity of the bond. It
appears that announcement shocks do not persist at all and that the information related to announcements are incorporated faster by the market than other kinds of
information. The conditional variance is highly persistent and there are not any statistical differences between positive and negative announcement shocks. Like-
wise, the persistency of the conditional volatility seems to be identical across bonds of different maturities.
The outline of this paper is as follows. In Section 2, the data as well as some preliminary results are presented. Subsequently, the multivariate model of the
