How Does Economic Policy Uncertainty Affect Stock Market Returns: Evidence from a Markov-Switching Model with Mixture Distribution Regimes

Abstract

AbstractIn this study, the Global Economic Policy Uncertainty Index (GEPU) is considered the core factor affecting seven global stock markets (Japan, UK, USA, China, Singapore, Germany, and India). The Markov-switching(MS) model with mixed distribution regimes is employed to investigate the nonlinear effect of GEPU on these stock markets. To validate our results, 36 MS model specifications are considered for each stock market. The analysis can be illustrated into two parts. First, various model specifications are compared to find the best fit model to explain the EPU impacts. Second, we investigate the two-regime effects of EPU on stock market returns. The results show that each stock market return has characteristics of non-normal distribution regime. We also find that the GEPU negatively impacts the stock market in the bearish regime, but it turns to have a positive in the bullish regime.KeywordsUncertainty indexMixture distribution regimesStock markets