The Asset Pricing Implications of Government Economic Policy Uncertainty

Abstract:     
Using a search-based measure to capture economic policy uncertainty for 21 countries, we find that when economic policy uncertainty increases by 1%, contemporaneous market returns fall by 2.9% and market volatility increases by 18%. An economic policy uncertainty factor-mimicking portfolio earns positive abnormal returns of 70 basis points per month and market-wide equity risk premiums increase for at least two years. Aggregate cash flows, especially private investment experience a level shift downward but return to normal growth rates after one quarter. Our results suggest that indecisiveness in government economic policymaking has material and long-lasting real and financial implications.

Number of Pages in PDF File: 51

Keywords: Political Uncertainty, Asset Pricing, Risk Premium

JEL Classification: F30, F50, G12, G15, G31, G38, H56, P16

working papers series