We develop a new index of economic policy uncertainty (EPU) based on newspaper coverage frequency Several types of evidence – including human readings of 12,000 newspaper articles – indicate that our index proxies for movements in policy-related economic uncertainty Our US index spikes near tight presidential elections, Gulf Wars I and II, the 9/11 attacks, the failure of Lehman Brothers, the 2011 debt-ceiling dispute and other major battles over fiscal policy Using firm-level data, we find that policy uncertainty raises stock price volatility and reduces investment and employment in policy-sensitive sectors like defense, healthcare, and infrastructure construction At the macro level, policy uncertainty innovations foreshadow declines in investment, output, and employment in the United States and, in a panel VAR setting, for 12 major economies Extending our US index back to 1900, EPU rose dramatically in the 1930s (from late 1931) and has drifted upwards since the 1960s

/pdf/measuring-economic-policy-uncertainty-4nrg3ei76f.pdf

Measuring Economic Policy Uncertainty

We analyze how changes in government policy affect stock prices. Our general equilibrium model features uncertainty about government policy and a government whose decisions have both economic and non-economic motives. The model makes numerous empirical predictions. Stock prices should fall at the announcements of policy changes, on average. The price fall should be large if uncertainty about government policy is large, and also if the policy change is preceded by a short or shallow economic downturn. Policy changes should increase volatilities and correlations among stocks. The jump risk premium associated with policy decisions should be positive, on average.

/pdf/uncertainty-about-government-policy-and-stock-prices-3rd98h1uoh.pdf

Uncertainty about Government Policy and Stock Prices

Using the policy uncertainty index of Baker, Bloom, and Davis (2013), we document a strong negative relationship between firm-level capital investment and the aggregate level of uncertainty associated with future policy and regulatory outcomes. More importantly, we find evidence that the relation between policy uncertainty and capital investment is not uniform in the cross section, being significantly stronger for firms with a higher degree of investment irreversibility and for firms which are more dependent on government spending. Our results lend empirical support to the notion that policy uncertainty can depress corporate investment by inducing precautionary delays due to investment irreversibility.

Policy Uncertainty and Corporate Investment

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.

/pdf/uncertainty-about-government-policy-and-stock-prices-2ejnhhht9m.pdf

We document cycles in corporate investment corresponding with the timing of national elections around the world. During election years, firms reduce investment expenditures by an average of 4.8% relative to non-election years, controlling for growth opportunities and economic conditions. The magnitude of the investment cycles varies with different country and election characteristics. We investigate several potential explanations and find evidence supporting the hypothesis that political uncertainty leads firms to reduce investment expenditures until the electoral uncertainty is resolved. These findings suggest that political uncertainty is an important channel through which the political process affects real economic outcomes.

Political Uncertainty and Corporate Investment Cycles

We document cycles in corporate investment corresponding with the timing of national elections around the world. During election years, firms reduce investment expenditures by an average of 4.8% relative to nonelection years, controlling for growth opportunities and economic conditions. The magnitude of the investment cycles varies with different country and election characteristics. We investigate several potential explanations and find evidence supporting the hypothesis that political uncertainty leads firms to reduce investment expenditures until the electoral uncertainty is resolved. These findings suggest that political uncertainty is an important channel through which the political process affects real economic outcomes.

https://onlinelibrary.wiley.com/doi/pdf/10.1111/j.1540-6261.2011.01707.x

https://www.federalreserve.gov/pubs/feds/2013/201364/201364pap.pdf

Policy uncertainty, irreversibility, and cross-border flows of capital

We examine the response of foreign (i.e., non-South Korean) investors to escalating political conflict and its impact on the South Korean stock market surrounding 13 North Korean military attacks between 1999 and 2010. Using domestic (i.e., South Korean) institutions and individuals as benchmarks, we evaluate the trading behavior and performance of foreign investors. Following attacks, foreigners increase their holdings of Korean stocks and buy more shares of risky stocks. Performance results show foreigners maintain their pre-attack level of performance while domestic individuals, who make the overwhelming majority of domestic trades, perform worse. In addition, domestic institutions improve their performance. Overall, the results are consistent with the predictions based on the benefits of international diversification. Unlike domestic individuals, foreigners trade more shares than usual and deviate from their general strategy of positive feedback trading.

Political Conflict and Foreign Portfolio Investment: Evidence from North Korean Attacks

We document novel evidence that political uncertainty has a dampening effect on corporate investment. Specifically, we find significant cycles in firm-level corporate investment corresponding with the timing of national elections across a sample of 48 countries between 1980 and 2004. During the year leading up to the election outcome, firms reduce investment expenditures by an average of 5.3%relative to non-election years, controlling for firm characteristics and economic conditions. We investigate several potential explanations and find evidence consistent with the hypothesis that political uncertainty generates cycles in investment expenditures in election years. In particular, we find that the investment cycles are more pronounced in countries with fewer checks and balances in place at election time, parliamentary political systems, civil law legal origins, and among countries with higher measures of economic risk. Within countries, the cycles are more pronounced for firms in politically sensitive industries, firms with high capital intensity, and firms with a lower proportion of sales coming from exports. We also find that investment cycles are stronger around elections with more uncertain outcomes as measured by the closeness of election result. Decreases in corporate investment correspond with temporary increases in corporate cash holdings in the year leading up to the election. Overall, these findings suggest that political uncertainty is an important determinant of corporate financial policies around the world.

Youngsuk Yook

Papers

Political Uncertainty and Corporate Investment Cycles

Political Uncertainty and Corporate Investment Cycles

Policy uncertainty, irreversibility, and cross-border flows of capital

Political Conflict and Foreign Portfolio Investment: Evidence from North Korean Attacks

Political Uncertainty and Corporate Investment