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Uncertainty about Government Policy and Stock Prices

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  • Lubos Pastor

    (University of Chicago Booth School of Business)

  • Pietro Veronesi

    (University of Chicago Booth School of Business)

Abstract

We analyze how changes in government policy affect stock prices. Our general equilibrium model features uncertainty about government policy and a government that has both economic and non-economic motives. The government tends to change its policy after performance downturns in the private sector. Stock prices fall at the announcements of policy changes, on average. The price fall is expected to be large if uncertainty about government policy is large, as well as if the policy change is preceded by a short or shallow downturn. Policy changes increase volatility, risk premia, and correlations among stocks. The jump risk premium associated with policy decisions is positive, on average.

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Paper provided by Becker Friedman Institute for Research In Economics in its series Working Papers with number 2010-008.

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Date of creation: 2010
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Handle: RePEc:bfi:wpaper:2010-008

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