58 Pages Posted: 24 Sep 2011 Last revised: 1 Jun 2013
Date Written: May 28, 2013
We develop a general equilibrium model of government policy choice in which stock prices respond to political news. The model implies that political uncertainty commands a risk premium whose magnitude is larger in weaker economic conditions. Political uncertainty reduces the value of the implicit put protection that the government provides to the market. It also makes stocks more volatile and more correlated, especially when the economy is weak. We find empirical evidence consistent with these predictions.
Keywords: political, uncertainty, government, risk premium, put, learning, Bayesian
JEL Classification: G12, G18
Suggested Citation: Suggested Citation