Economic policy uncertainty, risk and stock returns: Evidence from G7 stock markets

Abstract

• This paper examines uncertainties and risks on excess stock returns G7 markets using monthly observations. • The estimated results find evidence supporting positive risk-return relation not only for risk as measured by conditional volatility but also for downside risk. • The stock returns are negatively correlated with economic policy uncertainty innovation (ΔEPU) in both local and global sources. • In addition to the negative effect of ΔEPU on excess stock returns, evidence also demonstrates that lagged ΔEPU positively contributes to a rise in stock return volatility. • The conventional test of risk-return relation without controlling ΔEPU is subject to a specification bias.