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Central bank signals, behavioral biases, and information flow

Research output: Contribution to journalArticlepeer-review

Abstract

How central bank communications reshape market uncertainty is a fundamental question for monetary policy, yet existing tools, such as volatility proxies, event studies, and structural models, do not quantify directional information flow or account for behavioral distortions. This paper develops an information-theoretic framework to measure aggregate uncertainty using market entropy and to quantify directional information flows among assets using simulated and market data around Federal Reserve announcements. Results show that behavioral biases amplify short-term reactions to central bank signals, but these distortions fade as markets converge toward efficiency. Anticipated announcements reduce uncertainty, while unanticipated ones increase it, and such communications alter cross-asset dependence, weakening safe haven equity comovement while strengthening within-sector dependence. These findings reveal an information-transmission channel through which monetary policy signals reshape market dynamics beyond standard rational expectations benchmarks.
Original languageAmerican English
Article number107550
JournalEconomic Modelling
Volume158
DOIs
StatePublished - Feb 19 2026

Scopus Subject Areas

  • Economics and Econometrics

Keywords

  • Behavioral biases
  • Central bank communication
  • Information efficiency
  • Market entropy
  • Monetary policy transmission
  • Transfer entropy

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