Working Paper: NBER ID: w17464
Authors: Lubos Pastor; Pietro Veronesi
Abstract: We develop a general equilibrium model of government policy choice in which stock prices respond to political news. The model implies that political uncertainty commands a risk premium whose magnitude is larger in weaker 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, especially when the economy is weak. We find empirical evidence consistent with these predictions.
Keywords: Political Uncertainty; Risk Premium; Stock Prices; Asset Pricing
JEL Codes: G01; 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 correlations (C10) |
| political uncertainty (D89) | value of implicit government protections (G28) |
| weaker economic conditions (F69) | larger political risk premium (F31) |
| political shocks (F69) | revisions in investor beliefs (G41) |
| revisions in investor beliefs (G41) | stock prices (G12) |
| political uncertainty (D89) | stock prices (G12) |
| weaker economic conditions (F69) | stronger effects of political uncertainty (D89) |