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The Asset Pricing Implications of Government Economic Policy Uncertainty

Management Science 61(1), January 2015

53 Pages Posted: 4 Jun 2012 Last revised: 18 Apr 2015

Jonathan Brogaard

University of Washington - Department of Finance and Business Economics

Andrew L. Detzel

University of Denver - Daniels College of Business

Date Written: June 1, 2014

Abstract

Using the Baker, Bloom, and Davis (2013) news-based measure to capture economic policy uncertainty (EPU) in the United States, we find that EPU positively forecasts log excess market returns. A one-standard deviation increase in EPU is associated with a 1.5% increase in forecasted 3-month abnormal returns (6.1% annualized). Furthermore, innovations in EPU earn a significant negative risk premium in the Fama French 25 size-momentum portfolios. Among the Fama French 25 portfolios formed on size and momentum returns, the portfolio with the greatest EPU beta underperforms the portfolio with the lowest EPU beta by 5.53% per annum, controlling for exposure to the Carhart four factors as well as implied and realized volatility. These findings suggest that EPU is an economically important risk factor for equities.

Keywords: Political Uncertainty, Asset Pricing, Risk Premium

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

Suggested Citation

Brogaard, Jonathan and Detzel, Andrew L., The Asset Pricing Implications of Government Economic Policy Uncertainty (June 1, 2014). Management Science 61(1), January 2015. Available at SSRN: https://ssrn.com/abstract=2075375 or http://dx.doi.org/10.2139/ssrn.2075375

Jonathan Brogaard (Contact Author)

University of Washington - Department of Finance and Business Economics ( email )

Box 353226
Seattle, WA 98195
United States

Andrew L. Detzel

University of Denver - Daniels College of Business ( email )

2101 S. University Blvd
Denver, CO 80208
United States

HOME PAGE: http://portfolio.du.edu/adetzel

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