Long-Run Relation and Speed of Adjustment of Economic Policy Uncertainty and Excess Return Volatility

Abstract

This study examines the relationship between excess return volatility and economic policy uncertainty in U.S using monthly data for the period 1985-2011. The result reveals the existence of a long-run positive relationship between excess return volatility and economic policy uncertainty. The casualty test indicates that economic policy uncertainty Granger-causes excess return volatility. The vector error correction model result shows that previous values of economic policy uncertainty explain the variation in the excess return volatility. Moreover, the deviation of excess return from its long-run equilibrium level by 1 unit, it will adjust back by 7.56 percent of the deviation after a month.

Keywords: economic policy uncertainty, excess return volatility

JEL Classification: E60, G12, G14