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Political Uncertainty and Risk Premia

Author

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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.

Suggested Citation

  • Lubos Pastor & Pietro Veronesi, 2011. "Political Uncertainty and Risk Premia," Working Papers 2011-007, Becker Friedman Institute for Research In Economics.
  • Handle: RePEc:bfi:wpaper:2011-007
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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