The Asset-Pricing Implications of Government Economic Policy Uncertainty

Using the news-based measure of Baker et al. [Baker SR, Bloom N, Davis SJ (2013) Measuring economic policy uncertainty. Working paper, Stanford University, Stanford, CA] to capture economic policy uncertainty (EPU) in the United States, we find that EPU positively forecasts log excess market returns. An increase of one standard deviation in EPU is associated with a 1.5% increase in forecasted three-month abnormal returns (6.1% annualized). Furthermore, innovations in EPU earn a significant negative risk premium in the Fama–French 25 size–momentum portfolios. Among the Fama–French 25 portfolios formed on size and momentum returns, the portfolio with the greatest EPU beta underperforms the portfolio with the…