Measure Of Economic Policy Uncertainty Research Articles

Predicting equity premium using news-based economic policy uncertainty: Not all uncertainty changes are equally important

This study contributes to the growing research that uses the news-based measure of U.S. economic policy uncertainty (EPU) suggested in Baker et al. (2016) to predict economic variables out-of-sample. Using simple predictive regressions à la Goyal and Welch (2008), we evaluate the predictive power afforded by various nonlinear transformations of the U.S. EPU measure suggested in Baker et al. (2016) to predict excess returns on the S&P 500 index one-month ahead. Using data from 1985m1 through 2020m12, we find that not all EPU movements are equally important for obtaining point prediction improvements relative to the historical average benchmark at the population level. Particularly, we document that the one-year net EPU increase, defined as EPU increases beyond the peak over the last year, otherwise zero delivers the most consistent pattern of prediction improvements relative to the benchmark. Conversely, other nonlinear specifications as well as the linear models using log-EPU and the first difference of log-EPU do not deliver the same performance. Overall, this study documents that the predictive impact of the U.S. EPU index suggested in Baker et al. (2016) on equity premium is nonlinear in that EPU increases matter only to the extent that they exceed the maximum value over the last twelve months. In other words, there is evidence of threshold nonlinearity. The statistical predictive power afforded by the one-year net EPU increase also translates into economic gains.

Does economic policy uncertainty affect cryptocurrency markets? Evidence from Twitter-based uncertainty measures

Using daily data from August 9, 2015, to July 7, 2020, this study examines the effects of economic policy uncertainty (EPU) on the returns of four cryptocurrencies: Bitcoin, Ethereum, Litecoin, and Ripple. To this end, two new measures of EPU (Twitter-based economic uncertainty and Twitter-based market uncertainty) are considered. A Granger causality test using the recursive evolving window approach shows a significant causality between the Twitter-based EPU measures and the BTC/USD exchange rate from October 2016 to July 2017. Moreover, a significant causality was noted from the EPU measures to the ETH/USD exchange rate from June 2019 to February 2020 and from the EPU measures to the XRP/USD exchange rate from January 2020 to February 2020. The Twitter-based EPU measures primarily positively affect the returns of the related cryptocurrencies during these periods. These results are robust to different measures of Twitter-based EPU and different econometric techniques. Potential implications, including the COVID-19 era, are also discussed.

Role of global, regional, and advanced market economic policy uncertainty on bond spreads in emerging markets

This paper investigates the predictive content of news-based advanced market, regional, and global economic policy uncertainty (EPU) measures for bond spreads and their volatility in emerging markets (EMs) by extending the higher (k-th) order nonparametric causality-in-quantiles test to a multivariate case. Results show that global and advanced market EPU measures have predictive power for EM bond spreads in the lower and upper quantiles while for volatility, the predictive power is stronger in the upper quantiles and further observes predictability in the mid quantiles. Predictability detected for all EMs is characterized by an inherent heterogeneity leading to an asymmetric pattern over the distribution of EM bond spreads and volatility. The implication for heterogeneity in our results is that when EPU is high in advanced markets, global investors’ appetite for the EM local currency bonds increases due to high yields. However, when EPU is low, global investors move out of EMs because of the perceived unsafe investment environments in EMs.

Global Uncertainty and Firm Investment: Empirical Assessment

Global Economic Policy Uncertainty (EPU) and non-EPU global uncertainty measures exhibit heterogeneous behavior, especially in 2010s. Using firm-level data from 36 countries, we estimate the effect of global uncertainty on corporate investment in 1997–2016. Eleven global uncertainty measures, including global EPU, are employed to encompass macro, micro, and higher-order dimensions of uncertainty. We find different effect of EPU and non-EPU global uncertainty measures on investment. Only EPU measures negatively affect investment, while non-EPU measures have positive effects, which suggests a possible first-order implication of EPU.

Economic Policy Uncertainty and Bond Risk Premia

AbstractWe study the forecasting power of economic uncertainty about government policy for future bond returns. Using the economic policy uncertainty measure () developed by Baker, Bloom, and Davis (2016), we investigate its relationship to expected bond returns. The impact of the is shown to be large for earlier maturities at shorter investment horizons. Estimating an affine term structure model incorporating the , we show that term premia estimates from this model with this additional pricing factor exhibit higher fluctuations and move closely with the variations in observed yields. The implied term premia show strong countercyclical movements, hence better explaining higher risk compensation under adverse economic conditions as expected by theory.

Global uncertainty and Global Economic Policy Uncertainty: Different implications for firm investment

Global Economic Policy Uncertainty (EPU) and non-EPU global uncertainty measures exhibit heterogeneous behavior, especially in 2010s. Using firm-level data from 36 countries, we estimate the effect of global uncertainty on corporate investment in 1997–2016. Eleven global uncertainty measures, including global EPU, are employed to encompass macro, micro, and higher-order dimensions of uncertainty. We find different effect of EPU and non-EPU global uncertainty measures on investment. Only EPU measures negatively affect investment, while non-EPU measures have positive effects, which suggests a possible first-order implication of EPU.

Evaluating tail risks for the U.S. economic policy uncertainty

AbstractThe goal of this paper is to employ a relatively new methodological approach to extract quantile‐based economic policy uncertainty (EPU) risk forecasts using the Quantile Autoregressive Distributed Lag Mixed‐Frequency Data Sampling (QADL‐MIDAS) regression model recommended by Ghysels and Iania. This type of modelling delivers better quantile forecasts at various forecasting horizons. The forecasting results not only imply that the risk measure of EPU measure is linked to the future evolution of the index itself, but also it help constructing explicitly EPU risk measures, which are used to identify what drives such risk policy measures, especially across certain sub‐sample periods associated with major global events, such as the collapse of the Lehman Brothers, the Trump's election and the trade‐war tensions between the United States and China. The findings offer a new empirical perspective to the existing EPU literature, documenting that special world events carry a strong informational content as being a primary key to understand the dynamics of the economic policy tails.

US Policy Uncertainty and Stock Market Nexus Revisited through Dynamic ARDL Simulation and Threshold Modelling

Since the introduction of the measure of economic policy uncertainty, businesses, policymakers, and academic scholars closely monitor its momentum due to expected economic implications. The US is the world’s top-ranked equity market by size, and prior literature on policy uncertainty and stock prices for the US is conflicting. In this study, we reexamine the policy uncertainty and stock price nexus from the US perspective, using a novel dynamically simulated autoregressive distributed lag setting introduced in 2018, which appears superior to traditional models. The empirical findings document a negative response of stock prices to 10% positive/negative shock in policy uncertainty in the short-run, while in the long-run, an increase in policy uncertainty by 10% reduces the stock prices, which increases in response to a decrease with the same magnitude. Moreover, we empirically identified two significant thresholds: (1) policy score of 4.89 (original score 132.39), which negatively explain stock prices with high magnitude, and (2) policy score 4.48 (original score 87.98), which explains stock prices negatively with a relatively low magnitude, and interestingly, policy changes below the second threshold become irrelevant to explain stock prices in the United States. It is worth noting that all indices are not equally exposed to unfavorable policy changes. The overall findings are robust to the alternative measures of policy uncertainty and stock prices and offer useful policy input. The limitations of the study and future line of research are also highlighted. All in all, the policy uncertainty is an indicator that shall remain ever-important due to its nature and implication on the various sectors of the economy (the equity market in particular).

Economic policy uncertainty and stock market activity: Evidence from China

The effects of various China economic policy uncertainty (EPU) indices on Chinese listed firms' stock price behavior are examined in this study. We find that the mass media in China-based index is the best indicator of stock price crash risk for Chinese A- or B-share listings, but the index based on independent Chinese media is better for H-share listings. Chinese firms face a greater risk of stock price crashes during high EPU periods, but for B-share listings this relationship becomes negative after more media coverage is considered. We follow Baker, Bloom, and Davis (2016) and construct an EPU measure for the Chinese economy based on a Chinese character search of newspapers. We compare our EPU index with the BBD index of Baker, Bloom, and Davis (2016), which is based on an English-language Hong Kong news source. We find that the BBD index is a reasonable proxy for China's EPU but that it omits some useful information. We further demonstrate that our EPU index predicts China's economic trends more effectively than the BBD index, particularly when based on mass media in China.

Economic policy uncertainty and momentum

AbstractWe show that a news‐based measure of economic policy uncertainty (EPU) negatively forecasts momentum. A 1‐standard‐deviation increase in EPU is associated with a 1.11% decrease in risk‐adjusted momentum returns. The predictive power of EPU is robust after controlling for previously documented economic state variables and macroeconomic uncertainty. We provide an explanation for these results from the perspective of a fund flow‐induced trading mechanism and offer direct empirical support. The literature documents that momentum can be partially attributed to performance‐chasing mutual fund flows. We find that this flow‐induced mechanism functions more effectively in low EPU states, thereby generating stronger stock momentum.

Does Economic Policy Uncertainty Affect Cryptocurrency Markets? Evidence from Twitter-Based Uncertainty Measures

Using the daily frequency data for the period from August 9, 2015, to July 7, 2020, this paper re-examines the effects of the Economic Policy Uncertainty (EPU) on returns of four cryptocurrencies: Bitcoin, Ethereum, Litecoin, and Ripple. For this purpose, two new measures of the EPU (Twitter-based Economic Uncertainty and Twitter-based Market Uncertainty) are considered. The results from the Granger Causality test with the Recursive Evolving Window approach show that there is a significant causality from the Twitter-based EPU to the BTC/USD from October 2016 to July 2017. Besides, there is a significant causality from the EPU to the ETH/USD from June 2019 to February 2020, as well as from the EPU to the XRP/USD from January 2020 to February 2020. Mainly, the Twitter-based EPU measures positively affect the returns of related cryptocurrencies during these periods. These results are robust to consider different measures of the Twitter-based uncertainty as well as to apply different econometric techniques. Potential implications, including the COVID-19 era, are also discussed.

Examining the relationship between policy uncertainty and market uncertainty across the G7

Economic policy uncertainty (EPU) relates to ambiguity surrounding possible changes in government policy and their associate impact on firm performance. This uncertainty places additional stress on economic agents and has implications for the global economy via delays in firm investment and hiring, and postponement of household consumption. We utilise the EPU measure of Baker et al. (2016) to investigate whether financial market uncertainty is related to policy uncertainty across the G7 economies. Our empirical results show that financial market uncertainty (implied volatility) increases as economic policy uncertainty increases (and the economy weakens). This relationship holds even after controlling for macroeconomic state variables and country/time fixed effects, and is consistent for monthly and daily data frequency. The correlation of political uncertainty among countries varies over time, increasing in tranquil times with low EPU, and sharply decreasing during times of crisis. We also show that US and Japanese policy uncertainty has an economic and statistically significant relationship with global financial market uncertainty, a spill-over effect that is consistent with the size of their economies, and the important role that US policy decisions play in the global economy.

Economic policy uncertainty and fine wine prices

PurposeThe paper aims to investigate the impact of economic policy uncertainty (EPU) (i.e. uncertainty due to government policies) on fine wine prices.Design/methodology/approachThe paper uses the Baker et al. (2016) monthly news-based measure of EPU for the leading wine markets: the USA, the UK, France, Germany and China in conjunction with monthly fine wine pricing data from the London International Vintners Exchange (Liv-ex). The wine sub-indices used are the Liv-ex 500 (Bordeaux), Burgundy 150, Champagne 50, Rhone 100, Italy 100, California 50, Port 50 and Rest of the World 50. The Prais–Winsten and Cochrane–Orcutt regressions are used for our analyses to correct for effects of serial correlation. Time lags are chosen based on the appropriate information criterion.FindingsChanges in EPU levels negatively impact changes in the Liv-ex 500 index for all our leading wine markets except France, the Champagne 50 index for the UK and the Burgundy 150 and the Rhone 100 indices for Germany, with the effects being significant for at least up to a quarter before EPU is detected. The authors did not find significant results for the EPU of France.Practical implicationsThe paper aims to provide insights into whether EPU creates opportunities or threats for investors and wineries.Originality/valueA forward-looking news-based EPU measure is used to gain insights into how the different Liv-ex sub-indices react to increases in uncertainty centered around government policies across a sample of different countries.

Firm-Level Economic Policy Uncertainty, Firms’ Investment and Financial Assets

We use text mining tools to extract a measure of economic policy uncertainty perceived by individual Chinese listed firms from their annual report texts. We present this measure with some visualization techniques and it varies over time and across sectors in accordance with our intuitions. The dispersion of the perceived economic policy uncertainty measure rises significantly when the aggregate uncertainty goes high. The variation of this measure comes mainly from sector levels. Firms perceived economic policy uncertainties decrease corporate investment expenditures and increase holding financial assets. It is suggested that Chinese policy makers should increase process transparency when formulating economic policies, improve communication with firms and manage their expectations more effectively.

Cross-Category, Trans-Pacific Spillovers of Policy Uncertainty and Financial Market Volatility

Using generalised variance decompositions from vector autoregressions, we analyse cross-country, cross-category spillovers of economic policy uncertainty (EPU) and financial market volatility between the US and Japan. Our model includes indices of monetary, fiscal and trade policy uncertainty for each country, as well as three measures of option-implied stock market and exchange rate volatility, respectively. We find that the financial market volatility indices are usually substantial net spillover transmitters towards the total group of EPU measures. However, the Japanese equity and especially the FX volatility index are typically more affected by EPU spillovers than the US VXO. Our results also reveal that, compared to within-country spillovers, cross-country spillovers of EPU are relatively small and less volatile. Finally, we show that the direction of net EPU spillovers between the US and Japan is both time- and category-dependent with different EPU categories acting as strong sources of uncertainty spillovers throughout the sample period.

Economic policy uncertainty and credit growth: Evidence from a global sample

This study extends the research of Bordo, Duca, and Koch (2016) and Hu and Gong (2018) by examining the influences of economic policy uncertainty (EPU) at domestic and global levels on aggregate bank credit growth. The empirical analysis is conducted through both supply and demand side factors of bank credit growth in 22 economies over the period 2001–2015. This study employs different measures of EPU and applies panel-corrected standard errors (PCSE) and feasible generalized least squares (FGLS), which are suitable for unbalanced panel data models. Three principal findings are follows. First, higher level of EPU has negative impact on bank credit growth, which is significant for domestic EPU measures. Second, the positive change in EPU appears to have favorable effects on bank credit growth. The effects in both cases are different for the credit demand and supply sides. The findings suggest the need for appropriate measures to tackle bank credit risk-taking activities in uncertain conditions. Third, the impacts of EPU in emerging economies are negative and somewhat stronger than in advanced economies.

Election uncertainty, economic policy uncertainty and financial market uncertainty: A prediction market analysis

Abstract We examine the relationship between election uncertainty, economic policy uncertainty, and financial market uncertainty in a prediction-market analysis, covering seven US presidential election campaigns. We argue theoretically that changes in the incumbent party re-election probability should be a key driver of changes in policy uncertainty. Consistent with this theory, we find that a large portion of changes in financial uncertainty in the final stages of election campaign seasons is explained by changes in the probability of the incumbent party getting re-elected. Our findings suggest that the incumbent-party election probability, derived from prediction markets, is an important measure of economic policy uncertainty in the days leading up to US elections.

The effects of economic policy uncertainty on outward foreign direct investment

This research article aims to analyze the impact that economic policy uncertainty has on foreign direct investment (FDI), which has long remained elusive due to the challenge of thoroughly and accurately quantifying uncertainty. For this purpose, the recently developed Economic Policy Uncertainty Index (EPU Index) is used as a measure of economic policy uncertainty for both the U.S. and a panel of twenty U.S. Direct Investment Abroad (USDIA) host countries. The results demonstrate a strong causal link between the level of economy policy uncertainty and U.S. outward FDI flow. Outward FDI is found to peak three quarters after a shock in the domestic EPU Index, and to decrease two quarters after a shock in the host country's EPU Index. Our findings indicate the relevance of economic policy uncertainty for the investment decisions of multinational enterprises (MNEs) in the U.S., and show that it could represent a tool policy makers could use to forecast and monitor changes in foreign direct flow.

Forecasting equity premium in a panel of OECD countries: The role of economic policy uncertainty

This paper investigates whether the news-based measure of economic policy uncertainty (EPU) could help in forecasting the equity premium (excess returns) in ten (Canada, France, Germany, Italy, Japan, The Netherlands, South Korea, Spain, United Kingdom (UK), and United States (US)) Organization for Economic Co-operation and Development (OECD) countries. We analyze the monthly out-of-sample period of 2007:01-2014:12, given an in-sample period of 2003:03-2006:12, using panel data-based predictive frameworks, which controls for heterogeneity, cross-sectional dependence, persistence and endogeneity. Our results show that while, time series based predictive regression models fail to beat the benchmark of historical average, the panel data models consistently beat the benchmark in a statistically significant fashion. In general, our results highlight the importance of pooling information when trying to forecast excess stock returns based on a news-based measure of domestic EPU, as well as that of the US.

Does Economic Policy Uncertainty Matter for Financial Reporting Quality? Evidence from the United States

We examine the effect of economic policy uncertainty (EPU) on the financial reporting quality of US firms over 1999-2015. Using accruals-based earnings management as a proxy for financial reporting quality and the index of Baker et al. (2016) as an EPU measure we show that they exhibit a positive and significant association in accordance with the “lean against the wind” hypothesis. We also find a causal effect by employing the recently developed index of partisan conflict in the US Congress of Azzimonti (2018) as an instrument for EPU. In a cross-sectional analysis, we further show that the positive relationship between EPU and earnings management strengthens for riskier firms and firms belonging to politically sensitive industries. Overall, these results indicate that managers aim to provide outsiders with an improved financial picture of the company when EPU is high. These findings suggest that investors and regulators should be wary of firms’ financial reporting quality in periods of high economic policy uncertainty.