Political uncertainty and stock return: evidence from turnovers of Chinese local government leaders

This paper provides evidence about the asset pricing implication of political uncertainty in China. Under the assumption that there is a U-shape relationship between political uncertainty and the duration of Chinese local government leader in office, we propose a novel political uncertainty measure and investigate the impact of such uncertainty on the cross-section of expected stock returns. Using the A-share market data from 1998 to 2017, we find that the firms in the cities with higher political uncertainty tend to earn higher future stock returns, and this positive effect is more pronounced in regions with higher policy-sensitivity. These findings are robust to a battery of tests including using alternative calculation of political uncertainty, changing test horizons, testing in different subperiods and different market states. Further analysis shows that the positive relationship between political uncertainty and expected stock returns is mainly driven by the change in discount rather than change in the firm’s fundamentals.