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Uncertainty about Government Policy and Stock Prices




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    • Both authors are at the University of Chicago Booth School of Business, NBER, and CEPR. We are grateful for comments from Fernando Alvarez, Frederico Belo, Jaroslav Borovička, Pierre Chaigneau, David Chapman, Josh Coval, Max Croce, Steve Davis, Allan Drazen, Francisco Gomes, John Graham (Co-editor), Cam Harvey (Editor), John Heaton, Monika Piazzesi, Lukas Schmid, Amit Seru, Rob Stambaugh, Milan Švolík, Francesco Trebbi, Rob Vishny, and an anonymous referee, as well as from conference participants at the 2010 NBER AP, 2010 NBER EFG, 2011 WFA, 2011 EFA, 2011 SED, 2011 SITE, 2011 Prague Economic Meeting, 2011 European Summer Symposium in Financial Markets (Gerzensee), and 2011 Chicago Booth CFO Forum and workshop participants at the Bank of England, Chicago, Einaudi Institute (Rome), Erasmus, ECB, Harvard, LBS, LSE, McGill, Northwestern, Notre Dame, Oxford, Vanderbilt, Warwick, and WU Vienna. This research was funded in part by the Initiative on Global Markets at the University of Chicago Booth School of Business.


We analyze how changes in government policy affect stock prices. Our general equilibrium model features uncertainty about government policy and a government whose decisions have both economic and noneconomic motives. The model makes numerous empirical predictions. Stock prices should fall at the announcement of a policy change, on average. The price decline should be large if uncertainty about government policy is large, and also if the policy change is preceded by a short or shallow economic downturn. Policy changes should increase volatilities and correlations among stocks. The jump risk premium associated with policy decisions should be positive, on average.