Political Uncertainty and Risk Premia

61 Pages Posted: 7 Dec 2011 Last revised: 11 Dec 2012

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)

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Date Written: December 10, 2012

Abstract

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.

Suggested Citation

Pastor, Lubos and Veronesi, Pietro, Political Uncertainty and Risk Premia (December 10, 2012). Becker Friedman Institute for Research in Economics Working Paper No. 2011-007. Available at SSRN: https://ssrn.com/abstract=1969498 or http://dx.doi.org/10.2139/ssrn.1969498

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)

1050 Massachusetts Avenue
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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