Examining the relationship between policy uncertainty and market uncertainty across the G7

Lee Smales

International Review of Financial Analysis, 2020, vol. 71, issue C

Abstract: Economic policy uncertainty (EPU) relates to ambiguity surrounding possible changes in government policy and their associate impact on firm performance. This uncertainty places additional stress on economic agents and has implications for the global economy via delays in firm investment and hiring, and postponement of household consumption. We utilise the EPU measure of Baker et al. (2016) to investigate whether financial market uncertainty is related to policy uncertainty across the G7 economies. Our empirical results show that financial market uncertainty (implied volatility) increases as economic policy uncertainty increases (and the economy weakens). This relationship holds even after controlling for macroeconomic state variables and country/time fixed effects, and is consistent for monthly and daily data frequency. The correlation of political uncertainty among countries varies over time, increasing in tranquil times with low EPU, and sharply decreasing during times of crisis. We also show that US and Japanese policy uncertainty has an economic and statistically significant relationship with global financial market uncertainty, a spill-over effect that is consistent with the size of their economies, and the important role that US policy decisions play in the global economy.

Keywords: Economic policy uncertainty; Financial market uncertainty; Implied volatility; EPU; VIX (search for similar items in EconPapers)
JEL-codes: G10 G14 G15 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:71:y:2020:i:c:s1057521920301848

DOI: 10.1016/j.irfa.2020.101540

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