Tax Policy Uncertainty and Stock Return Volatility

Abstract

This study finds that stock return volatility is higher during periods of high tax policy uncertainty (TPU), even after controlling for other sources of general macroeconomic uncertainty. Further, we find that the relation between TPU and stock return volatility is more pronounced where firms are characterized by greater variability in tax outcomes. We adopt a broad definition of TPU that encompasses both the legislative and regulatory processes, and we perform tests to validate a news-based measure of TPU that is consistent with this definition. In supplemental tests, we document an increase in analyst forecast dispersion during periods of high TPU, indicating the effects of tax policy uncertainty extend to sophisticated market participants. We also document that the effects of TPU are concentrated in systematic volatility. Overall our results suggest that uncertainty surrounding tax policy can impose real costs on investors.

Keywords: tax policy uncertainty, economic policy uncertainty, return volatility

JEL Classification: H25, H32, G18, M41, D72, G12