The Stock Market’s Reaction to Unemployment News :
Why Bad News Is Usually Good for Stocks
John H. Boyd, Jian Hu, and Ravi Jagannathan
Reporter :吳嘉洋
October 20, 2010
1
Introduction
• The stock market’s response to unemployment
news arrival depends on whether the economy
is expanding or contracting.
• The stock market responds positively to news of
rising unemployment in expansions, and
negatively in contractions.
• The economy is usually in an expansion phase,
it follows that the stock market usually rises on
the announcement of bad news from the labor
market.
2
Three Primitive Factors Determine Stock Price
Risk-free rate of interest
Unemployment news
Growth expectations
Stock price
Equity risk premium
3
Outline
• Data and Methodology
• Stock and Bond Price Responses to Unemployment
News
• Unemployment News, Growth Expectations, and the
Equity Risk Premium
• Summary and Conclusions
4
Data
• Unemployment Announcements
– From February 1957 to December 2000.
– At 8:30 a.m. on Friday.
– It also releases revisions of past unemployment announcements
for the previous 3 months.
5
Unemployment news
– Anticipated
– Unanticipated (Surprise component)
Surprise component
= actual unemployment rate – forecasted unemployment rate
6
Measuring Unemployment News
•
•
•
•
DUMPt : the change in the unemployment rate.
IPGRATEt : the growth rate of monthly industrial production.
DTB3t : the change in the 3-month T-bill rate.
DBAt : the change in the default yield spread between Baa and
Aaa corporate bonds.
7
Estimation Method (1)
• We used final release numbers for unemployment and
industrial production and we also included a dummy
variable, which took on the value 1.0 during contractions
and 0.0 during expansions.
DUMPt  b0  D(b1 IPGRATEt 1  b2 IPGRATEt 2  b3 IPGRATEt 4
 b4 DUMPt 1  b5 DTB3t  b6 DBA)  (1  D)(c1 IPGRATEt 1
 c2 IPGRATEt 2  c3 IPGRATEt 4  c4 DUMPt 1  c5 DTB3t
 c6 DBA)  et
8
Estimation Method (2)
• Second estimation method uses final release
numbers for unemployment and industrial
production and omits the business cycle dummy
variable.
9
Estimation Method (3)
• The third forecasting method use final release figures for
the unemployment rate and the IIP, but only employs
data available up to 1 year before the estimation date.
Then we employ the estimated parameters and the initial
release numbers of the unemployment rate data and
originally published and subsequently revised IIP to
construct our estimate of the unemployment surprise.
Final data
Initial data
2009.12
Estimate
parameters
2010.12
10
11
Daily Returns on Stocks and Bonds
• Define daily stock returns as the percentage
change in the S&P 500 stock index.
• Daily bond returns are constructed from daily
yields.
12
-0.01
0.41
0.36
0.115
-0.24

0.109
13
Stock Price Responses to Unemployment News
• SPRTRNt : the return on day t on the S&P 500 index.
• ERRUMPt : the surprise component of the unemployment rate
announcement.
• XRICt : an estimate of the probability that the economy was in a
recession.
14
15
Bond Price Responses to Unemployment News
• BRTRNt : the return on the bond of interest on date t.
• The dependent variables are the return on a hypothetical 1-year
government bond, the 3-month T-bill, and the 10-year government
bond.
16
17
Summary - Stock and Bond
• Government bond price responses to the arrival
of unemployment news are different from stock
prices.
• Moreover, the unemployment news must convey
information about the other two primitive factors,
namely, growth rate expectations and the equity
risk premium.
18
Unemployment News, Growth Expectations,
and the Equity Risk Premium
• Gordon model
•
•
•
•
•
r : interest rate on long-term risk-free
P : price of a security or portfolio
D : the current dividend
g : weighted average of expected future growth rates
π : the risk premium investors required to invest in
stocks
19
• u denote the unanticipated surprise in the
unemployment rate (ERRUMP)
(1 
D 1 r  

)
P
1 g
20
21
The Equity Risk Premium: Its
Response to Unemployment News
• Lee, Myers, and Swaminathan (1999) (hereafter LMS)
show that the intrinsic value to price ratio (V/P) of Dow
30 stocks has a statistically and economically significant
ability to predict future excess returns on the Dow 30
stocks.
• We employ the V/P ratio they compute as a proxy for the
equity premium.
22
23
Growth Expectations: Their Response
to Unemployment News
• We estimated the true relationship between the
announced unemployment rate (the actual rate, not the
surprise component) and subsequent dividend growth,
using the IIP as a monthly proxy for corporate dividends.
24
25
Summary and Conclusions
• Stock prices rise when there is bad labor market
news during expansions, and fall during
contractions.
• There are two factors that affect the price of
stocks. One is the equity risk premium and the
other is the expected future growth rate of
dividends.
• Stock price responds to unemployment shocks,
and is larger during contractions than during
expansions.
26