The Effects of Economic Policy Uncertainty on the Indian Stock Market

Abstract

This paper investigates the impact of macroeconomic variables and economic uncertainty on the size of portfolio returns in the Indian stock market. Results show that economic policy uncertainty—in addition to macroeconomic variables—can play a big role in explaining the returns of Indian stocks. Since investors cannot reduce such risk by constructing well-diversified portfolios, it is in fact a source for systematic risk, which must be considered by investors when making investment decisions. However, Granger-causality tests show that there is a unidirectional causality running from portfolio returns to economic policy uncertainty. That is, the Indian stock market predicts economic policy uncertainty, not the other way around.