Political Uncertainty and Risk Premia

Lubos Pastor, Pietro Veronesi

NBER Working Paper No. 17464
Issued in September 2011
NBER Program(s):   AP   EFG   POL

We develop a general equilibrium model of government policy choice in which stock prices respond to political news. The model implies that political uncertainty commands a risk premium whose magnitude is larger in weaker 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, especially when the economy is weak. We find empirical evidence consistent with these predictions.

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This paper was revised on April 2, 2013

Acknowledgments

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