What Triggers Market Jumps?

Market cycles are expected, but the reasons for a switch to an up or down market are less understood.

In a typical cycle, downward market jumps eventually yield to bullish sentiment and the market bounds upward. All boats rise with the tide. But what triggers market jumps?

Researchers from the National Bureau of Economic Research (NBER) found that policy news—tied to monetary policy and government spending—triggered a larger proportion of stock market jumps than macroeconomic news or corporate earnings in the U.S. Jumps tied to policy news were also more likely to induce upward movement than downward movement.

Jumps in the U.S. stock market were defined as a daily move of at least 2.5%, upward or downward. Overall, these large movements are infrequent, accounting for only 3.5% of all trading days over the 20th century and first two decades of the 21st century. Despite their infrequency, stock market jumps accounted for about 20% of total daily variation.

However, bond markets showed different reactions than stock markets over the period studied. Jumps in bond markets were similarly tied to monetary policy news but were also driven by macroeconomic news.

In either market, jumps tied to monetary policy and government spending were most likely to be upward movements. The researchers noted that upward jumps tied to policy news tended to follow a quarter of negative market returns.

The researchers noted that the relationship between policy news and upward jumps is increasing over time. From 1980 to 2020, upward market jumps tied to policy news were twice as common as the respective downward jumps. Over the same period, downward jumps related to non-policy news or factors were almost twice as common as the respective downward jumps.

Jumps tied to monetary policy particularly marked future market movements. Market volatility was found to be much lower after jumps triggered by reactions to monetary policy, and the lower volatility was even more pronounced given greater clarity as to the reason why the market moved.

Researchers noted that a trend in increasing clarity between market jumps and the reasons why has improved since 1980.

Source: “What Triggers Stock Market Jumps;” by Scott R. Baker et al., National Bureau of Economic Research, 2021.