Government Spending Shocks and Asset Prices

Abstract

I explore asset pricing implications and macroeconomic dynamics of government spending shocks. Using an exogenous measure that is available at a higher frequency, I show that news shocks about government spending are priced in the cross-section of asset returns. The shock is priced in a combined cross-section of bond, commodity futures, and equity returns and is robust to controlling for political cycle and business cycle variations. Using vector autoregressions, I show that a positive news shock reduces economic policy and geopolitical uncertainties. Assets with high sensitivity to shocks have higher returns since they have higher payoffs during low uncertainty states.

Keywords: government spending shock, GMP returns, asset pricing model, factor model

JEL Classification: G12, E62, N42