Management Science 61(1), January 2015
53 Pages Posted: 4 Jun 2012 Last revised: 18 Apr 2015
Date Written: June 1, 2014
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: 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