The Asset-Pricing Implications of Government Economic Policy Uncertainty

Using the Baker, Bloom, and Davis (2013) news-based measure to capture economic policy uncertainty (EPU) in the United States, we find that EPU positively forecasts log excess market returns. A one-standard deviation increase in EPU is associated with a 1.5% increase in forecasted 3-month abnormal returns (6.1% annualized). Furthermore, innovations in EPU earn a significant negative risk premium in the Fama French 25 size-momentum portfolios. Among the Fama French 25 portfolios formed on size and momentum returns, the portfolio with the greatest EPU beta underperforms the portfolio with the lowest EPU beta by 5.53% per annum, controlling for exposure to the Carhart four factors as well as implied and realized volatility. These findings suggest that EPU is an economically important risk factor for equities. * We have benefited from discussions with Scott Baker, Nicholas Bloom, Benjamin Born, Fousseni D. Chabi Yo, Stijn Claessens, Zhi Da, Stefano Giglio, Alan Hess, Marc Lipson, Lubos Pastor, Stephan Siegel, and Mitchell Warachka. We also appreciate helpful feedback from seminar participants at the ANU Research School of Finance, Actuarial Studies and Applied Statistics Summer Conference, The University of Chicago’s Becker Friedman Institute Conference on Policy Uncertainty and its Economic Implications, The Darden School of Business International Finance Conference, The Netspar Pension Workshop, The Mcgill Global Asset Management Conference, The WU Gutmann Soverign Credit Risk and Asset Management Symposium, and the University of Washington. All errors are our own. Contact: Jonathan Brogaard, Foster School of Business, University of Washington, (Email) [email protected], (Tel) 206-685-7822; Andrew Detzel, Foster School of Business, University of Washington, (Email) [email protected], (Tel) 206-685-4913.