Fiscal Policy, Consumption Risk, and Stock Returns: Evidence from US States∗

We find that the consumption risk of investors is lower in states that implement countercyclical fiscal policies. Moreover, firms whose investor base are concentrated in counter-cyclical states have lower stock returns, along with firms that relocate their headquarters to a countercyclical state. Therefore, counter-cyclical fiscal policies lower the consumption risk of investors and consequently their required equity return premium. This conclusion is confirmed by smaller declines in market participation during recessions in counter-cyclical states. Overall, the location of a firm’s investor base enables state-level fiscal policy to influence stock returns.