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Economic policy uncertainty and stock market in G7 Countries: A panel threshold effect perspective

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  • Maysoon Khojah
  • Masood Ahmed
  • Muhammad Asif Khan
  • Hossam Haddad
  • Nidal Mahmoud Al-Ramahi
  • Mohammed Arshad Khan

Abstract

Based on the literature, it is commonly understood that stock prices (SP) are influenced by economic policy uncertainty (PU), with a rise in PU typically having a negative impact on SP. However, the relationship between PU and SP may not always be linear due to the varying risk preferences of individuals. Risk preference theory posits that individuals respond differently to different levels of risk. Therefore, this study aims to investigate whether PU determines SP asymmetrically (i.e., in a non-linear manner) by considering risk preferences and addressing a gap in the literature. To answer this question, the study employs a panel threshold approach to examine the effect of PU on SP in the Group of Seven (G7) countries, namely Canada, France, Germany, Italy, Japan, UK, and the US. In contrast to previous research, this study finds evidence of an asymmetric effect of PU on SP in the G7 countries. Specifically, the panel threshold results reveal that the impact of increased PU on SP is positive up to a certain level (Threshold1), beyond which it becomes negative (Threshold2). These findings are in line with information asymmetry hypothesis, prospect theory, behavioural finance hypothesis, and market liquidity hypothesis and shed light on the asymmetric behaviour of SP in response to varying levels of PU. The implications of these findings are significant for understanding how to manage risks effectively in the financial markets.

Suggested Citation

  • Maysoon Khojah & Masood Ahmed & Muhammad Asif Khan & Hossam Haddad & Nidal Mahmoud Al-Ramahi & Mohammed Arshad Khan, 2023. "Economic policy uncertainty and stock market in G7 Countries: A panel threshold effect perspective," PLOS ONE, Public Library of Science, vol. 18(7), pages 1-19, July.
    • Handle: RePEc:plo:pone00:0288883
    DOI: 10.1371/journal.pone.0288883
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    References listed on IDEAS

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    1. Lubos Pástor & Pietro Veronesi, 2012. "Uncertainty about Government Policy and Stock Prices," Journal of Finance, American Finance Association, vol. 67(4), pages 1219-1264, August.
    2. Bernal, Oscar & Gnabo, Jean-Yves & Guilmin, Grégory, 2016. "Economic policy uncertainty and risk spillovers in the Eurozone," Journal of International Money and Finance, Elsevier, vol. 65(C), pages 24-45.
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    4. Arouri, Mohamed & Estay, Christophe & Rault, Christophe & Roubaud, David, 2016. "Economic policy uncertainty and stock markets: Long-run evidence from the US," Finance Research Letters, Elsevier, vol. 18(C), pages 136-141.
    5. Arouri, Mohamed & Estay, Christophe & Rault, Christophe & Roubaud, David, 2016. "Economic policy uncertainty and stock markets: Long-run evidence from the US," Finance Research Letters, Elsevier, vol. 18(C), pages 136-141.
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