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

ABSTRACT

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.

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