Wall Street Watches Washington: Asset-Pricing Implications of Policy Uncertainty

Abstract

We examine the effect of economic policy uncertainty (EPU) on analysts' forecasts, and how this uncertainty influences the information incorporated in stock prices. We find that periods of elevated EPU are associated with higher analyst disagreement, a decrease in forecast accuracy, and more conservatism. We show that the decrease in forecast accuracy can be partially attributed to limited attention to firm-specific earnings news. Finally, we demonstrate that investors do not correct for a decrease in forecast accuracy during periods of elevated EPU. Our results provide evidence that investors overweight analyst forecasts, also when forecast accuracy decreases during high EPU regimes. This has important implications for asset pricing, as the price discovery process may be distorted.

Keywords: attention, earnings announcements, economic policy uncertainty, analyst forecasts

JEL Classification: G12, G14, G18, G41