Reactions to FOMC Decisions Across Sectors: Studying Investor Behavior in the US Stock Market

Abstract

Using FOMC Federal Funds rate decisions over the past five years and executing event studies for ten representative firms of eleven stock market sectors, this paper attempts to identify patterns in trading reactions to the size of interest rate changes. Building on the theory of discounted cash flows ideated by Fisher (1930), the application of Fama (1965) is made to analyze the speed with which reactions occur most frequently. Using both the Mean Adjusted and Market Models for abnormal return calculations the Cumulative Abnormal Returns (CAR) are studied across a period from day 0 to day 3 post-event, as directed by the data. The magnitude of interest rate changes had little to no effect on the size of trading reactions for interest rate cuts but had a consistent and significant impact on that of interest rate hikes. The results of both the general OLS models and isolated samples of only 25 basis point changes, positive or negative, were in line with the loss-aversion theory of Kahneman and Tversky but also alluded to the overpowering of negative economic headwinds in driving trading reactions to rate hikes. Finally, difference in reactions across sectors was seen and fell in line with popular views about the fundamental business models specific to certain sectors and their respective dependence on interest rate levels.