Uncertainty about Government Policy and Stock Prices

Abstract:     
We analyze how changes in government policy affect stock prices. Our general equilibrium model features uncertainty about government policy and a government whose decisions have both economic and non-economic motives. The model makes numerous empirical predictions. Stock prices should fall at the announcements of policy changes, on average. The price fall should be large if uncertainty about government policy is large, and also if the policy change is preceded by a short or shallow economic downturn. Policy changes should increase volatilities and correlations among stocks. The jump risk premium associated with policy decisions should be positive, on average.

Number of Pages in PDF File: 54

Keywords: government, policy, uncertainty, learning, stock, price

JEL Classification: G01, G12, G14, G18

Accepted Paper Series