Wall Street Watches Washington: Asset-Pricing Implications of Policy Uncertainty

Abstract

We study the effect of economic policy uncertainty (EPU) on sell-side analysts’ forecasts, and how it interact with the stock-market response to a firm’s earnings news. We find that analysts tend to disagree more when faced with higher levels of EPU, and that their forecasts tend to be less precise and more conservative. The lower forecast accuracy can be attributed to distraction: during higher EPU, analyst attention is attracted to the overall stock market, while distracted to firm-specific earning news. In addition, we find that higher EPU mutes the trading volume reaction to earnings surprises and that investors do not unravel biases in analyst forecasts. Our results suggest that during high EPU regimes investors naively follow analysts’ forecasts, independent of their accuracy and credibility.