The Premium of Economic Policy Uncertainty Beta: An Explanation Based on the Certainty Effect

Abstract

In order to deal with complex international situations and arduous domestic reform and development tasks, especially the serious impact of the COVID-19 epidemic, the Chinese government actively plays the macroeconomic regulation and control role of economic policies, and makes economic policy uncertainty constantly increasing. According to the classical asset pricing theory, assets with high risk exposure will demand high expected return, thus there should be a positive risk premium for economic policy uncertainty exposure. In this paper, we take A-share in the Chinese stock market as the research sample, and use the Beta coefficient of the regression of stock returns to economic policy uncertainty as the risk exposure of economic policy uncertainty. We find that economic policy uncertainty Beta can produce significant negative premium, and cannot be explained by other stock characteristics, industries and equity natures, which obviously goes against the asset pricing theory.By analyzing the mechanism, it is found that when economic policy uncertainty is increasing, the stock price with higher economic policy uncertainty Beta is also increasing. For the sake of uncertainty aversion, investors will reduce their holdings of these stocks in the future, so as to produce lower expected returns. However, there is no significant relationship between economic policy uncertainty Beta and expected returns for stocks with lower economic policy uncertainty Beta and when economic policy uncertainty is weakening. Therefore, the negative premium of economic policy uncertainty Beta is caused by the certainty effect of investors. Although investors always use the economic policy to carry out arbitrage transactions, which may produce arbitrage risks, the negative premium of economic policy uncertainty Beta is not caused by arbitrage risks.Furthermore, we construct the economic policy uncertainty factor, and find that the five-factor model including FF3 factor, profitability factor and economic policy uncertainty factor has better pricing efficiency on cross-sectional stock returns in the Chinese stock market. We suggest that the economic policy has a “double-edged sword” effect, and high economic policy uncertainty will produce negative economic consequences. Facing the great challenge of profound changes in the global economic environment in the post epidemic era, strengthening the continuity, stability and sustainability of economic policies under the macro-prudential framework is conducive to maintaining the confidence of investors and the stability of the financial market.