Working Paper: CEPR ID: DP8601
Authors: Lubo Pstor; Pietro Veronesi
Abstract: We study the pricing of political uncertainty in a general equilibrium model of government policy choice. We find that political uncertainty commands a risk premium whose magnitude is larger in poorer economic conditions. Political uncertainty reduces the value of the implicit put protection that the government provides to the market. It also makes stocks more volatile and more correlated when the economy is weak. In addition, we find that government policies cannot be judged by the stock market response to their announcement. Announcements of deeper reforms tend to elicit less favorable stock market reactions.
Keywords: Bayesian; Government Learning; Political Put; Risk Premium; Uncertainty
JEL Codes: G12; G18
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| political uncertainty (D89) | risk premium (G19) |
| political uncertainty (D89) | stock volatility (G17) |
| political uncertainty (D89) | stock movements (G10) |
| weaker economic conditions (F69) | political risk premium (F31) |
| political uncertainty + government policies (E60) | market perceptions (G14) |
| political shocks (F69) | stock prices (G12) |
| implicit put option + political uncertainty (D84) | equity premium (G12) |