Dynamic Co-movements between Stock Market Returns and Policy Uncertainty

In this paper we examine the extent of time-varying correlations between stock markets returns and policy uncertainty based on a newly introduced uncertainty index by Baker et al. (2012). We identify several empirical regularities: (1) the dynamic correlations of policy uncertainty and stock market returns are consistently negative. (2) Increased stock market volatility increases policy uncertainty and dampens stock markets returns. (3) Increases in the volatility of policy uncertainty lead to negative stock market returns and increased uncertainty. (4) Oil specific demand shocks and domestic shocks (price and income shocks) lead to further increase in the negative correlation between policy uncertainty and stock market returns.