Political Uncertainty and Risk Premia

54 Pages Posted: 1 Nov 2011

See all articles by Lubos Pastor

Lubos Pastor

University of Chicago - Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Pietro Veronesi

University of Chicago - Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Multiple version iconThere are 5 versions of this paper

Date Written: October 2011

Abstract

We study the pricing of political uncertainty in a general equilibrium model of government policy choice. We find that political uncertainty commands a risk premium whose magnitude is larger in poorer 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 when the economy is weak. In addition, we find that government policies cannot be judged by the stock market response to their announcement. Announcements of deeper reforms tend to elicit less favorable stock market reactions.

Keywords: Bayesian, government, learning, political, put, risk premium, uncertainty

JEL Classification: G12, G18

Suggested Citation

Pastor, Lubos and Veronesi, Pietro, Political Uncertainty and Risk Premia (October 2011). CEPR Discussion Paper No. DP8601, Available at SSRN: https://ssrn.com/abstract=1952468

Lubos Pastor (Contact Author)

University of Chicago - Booth School of Business ( email )

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Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
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Pietro Veronesi

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-6348 (Phone)
773-702-0458 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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