Working Paper: CEPR ID: DP7897
Authors: Lubo Pstor; Pietro Veronesi
Abstract: We analyze how changes in government policy affect stock prices. Our general equilibrium model features uncertainty about government policy and a government that has both economic and non-economic motives. The government tends to change its policy after performance downturns in the private sector. Stock prices fall at the announcements of policy changes, on average. The price fall is expected to be large if uncertainty about government policy is large, as well as if the policy change is preceded by a short or shallow downturn. Policy changes increase volatility, risk premia, and correlations among stocks. The jump risk premium associated with policy decisions is positive, on average.
Keywords: government; learning; stock; uncertainty
JEL Codes: G01; G12; G14; G18
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government policy changes (O24) | stock prices (G12) |
| policy uncertainty (D89) | stock price volatility (G17) |
| political uncertainty (D89) | stock price volatility (G17) |
| greater uncertainty (D89) | larger expected declines in stock prices (G17) |
| negative announcement returns (G14) | short or shallow downturns (E32) |
| previous downturns (E32) | stock price reactions at policy announcements (G14) |
| policy changes (J18) | expected value of stock returns (G17) |