DP8601 Political Uncertainty and Risk Premia

Author(s):	Lubos Pástor, Pietro Veronesi
Publication Date:	October 2011
Keyword(s):	Bayesian, government, learning, political, put, risk premium, uncertainty
JEL(s):	G12, G18
Programme Areas:	Public Economics, Financial Economics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=8601

We study the pricing of political uncertainty in a general equilibrium model of government policy choice. We find that political uncertainty commands a risk premium whose magnitude is larger in poorer economic conditions. Political uncertainty reduces the value of the implicit put protection that the government provides to the market. It also makes stocks more volatile and more correlated when the economy is weak. In addition, we find that government policies cannot be judged by the stock market response to their announcement. Announcements of deeper reforms tend to elicit less favorable stock market reactions.