Uncertainty about Government Policy and Stock Prices
- Author(s): L̆UBOS̆ PÁSTOR, PIETRO VERONESI
- Published: Jul 19, 2012
- Pages: 1219-1264
- DOI: 10.1111/j.1540-6261.2012.01746.x
We analyze how changes in government policy affect stock prices. Our general equilibrium model features uncertainty about government policy and a government whose decisions have both economic and noneconomic motives. The model makes numerous empirical predictions. Stock prices should fall at the announcement of a policy change, on average. The price decline should be large if uncertainty about government policy is large, and also if the policy change is preceded by a short or shallow economic downturn. Policy changes should increase volatilities and correlations among stocks. The jump risk premium associated with policy decisions should be positive, on average.