Economic Policy Uncertainty and Stock Market Returns

Abstract

This paper investigates how stock market returns respond to economic policy uncertainty shocks. Based on the vector autoregression (VAR) analysis of the monthly changes in economic policy uncertainty index in the United States and CRSP value-weighted index from 1985:M2 to 2012:M6, the results show that stock returns negatively respond to economic policy uncertainty shocks in the first, fourth, fifth, eighth, night, tenth and eleventh months. In addition, the results from Granger causality Wald tests show that economic policy uncertainty is helping in predicting stock returns. Finally, the results from the time-varying OLS regression also show that changes in economic policy uncertainty index predict negative stock returns.

Keywords: economic policy uncertainty, stock returns, VAR

JEL Classification: E60, G12, G14