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Abstract

This article examines effects of monetary policy surprises on returns, volatilities, trading volumes, and bid–ask spread of two equity ETFs, the S&P 500 SPY fund and the S&P 400 MDY fund. The policy surprises are measured by both surprises in the federal funds rate target changes and surprises in the future direction of the Federal Reserve monetary policy. The results show that there is an overreaction of the SPY to the federal funds rate target surprise in the first 5 minutes' trading and that both the SPY and the MDY returns, volatilities, trading volumes, and bid–ask spread react more strongly to surprise cuts than to surprise increases in the federal funds rate target. Quantitatively, after 45 minutes, an unanticipated 25-basis-point cut in the federal funds rate target is associated with an increase of 1.2 and 1.6% in the SPY and the MDY, respectively, while an unanticipated 25-basis-point decline (or rise) in the four-quarter-ahead eurodollar futures rate is associated with an increase (or decrease) of 0.71 and 0.40% in the SPY and the MDY, respectively. Further evidence also suggests that the market reacts more strongly to surprises in the future direction of monetary policy during the monetary tightening period and that the impact of monetary policy surprises depends on their sizes. © 2006 Wiley Periodicals, Inc. Jrl Fut Mark 26:959–995, 2006