The Impulse Response Function of Economic Policy Uncertainty and Stock Market Returns: A Look at the Eurozone

Abstract

This paper examines the impulse response function of economic policy uncertainty (EPU) and stock market returns in the Eurozone. Using a vector autoregression analysis, this study explores how the Eurozone’s stock market responds to the impulse of economic policy uncertainty; a response feedback from the stock market is also examined. Using monthly data of the changes in economic policy uncertainty index and returns on the index of Eurozone stock market from 1993 to 2012, this study shows that Eurozone stock market returns respond positively to the changes in economic policy uncertainty; this response is statistically significant in the second, seventh and eighth months. However, the pooled OLS shows that the increase in the changes in economic policy uncertainty predicts lower stock market returns. The results also reveal a strong feedback from the stock market. The changes in economic policy uncertainty are significantly lower in the first, fourth and eighth months when the impulse is stock market returns.