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Political Uncertainty and Risk Premia

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  • Lubos Pastor
  • Pietro Veronesi

Abstract

We develop a general equilibrium model of government policy choice in which stock prices respond to political news. The model implies that political uncertainty commands a risk premium whose magnitude is larger in weaker economic conditions. Political uncertainty reduces the value of the implicit put protection that the government provides to the market. It also makes stocks more volatile and more correlated, especially when the economy is weak. We find empirical evidence consistent with these predictions.

Suggested Citation

  • Lubos Pastor & Pietro Veronesi, 2011. "Political Uncertainty and Risk Premia," NBER Working Papers 17464, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:17464
    Note: AP EFG POL
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    More about this item

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • 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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