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Does Economic policy and political uncertainty effect stock market performance and firms’ investment
This paper examines the effect of economic policy and political uncertainty and its components on stock market performance and firm’s investment in United Kingdom and United States. It is found that economic policy and political uncertainty in relation with firms’ level investment in United Kingdom and United States which is shown by the volatility of stock market index depress firm’s investment decisions. When firms are uncertain about the profit or loss in making an investment to the company or are doubt about cost of doing business, hence they become more careful with investment strategy as there will always have possibility for regulation, tax and health care to change. Firms with higher risk and during recession are more likely to have are highly sensitive to economic policy and political uncertainty. The effect of economic policy and political uncertainty on stock market performance in United Kingdom shows that the increase in uncertainty could reduce the stock market performance. However, in United States, the stock market performance does not seem to be influenced by economic policy and political uncertainty. As during recession and economic and politic uncertain, firms will hold their investment until the uncertainty and recession are recovered. This might help to control the negative impact of economic policy and political uncertainty on stock market performance.
Concerns about economic policy and political uncertainty have triggered in the wake of the global economy and financial crisis, impact on stock market and investors decision. Economic policy are divided into more than one category such as Monetary, fiscal, healthcare, national security, regulatory, political, and trade policy. One of these category could be one of the main driver to economic uncertainty. Christopher Thiem (2018) research found that fiscal policy plays an important role as net transmitter of uncertainty shocks, while trade policy is only a weak integrated and a distinct net receiver. Christopher Thiem (2018) all add that in the short run, the total of economic policy uncertainty connectedness reacts significantly to many events in- and outside of the political sphere. The auditor also argue that large movements in the level of policy-related uncertainty do not always trigger significant spill over effects and vice versa. For example, The New York Times mention in the paper that the even when Britain exit from the European Union shocked global markets. Also it is found that the pound plunged to its lowest level since 1985. People in corporation, investors and stakeholders of a company are very particular in the performance of stock either in a market or a company. The price of a company’s shares are frequently use as an indicator in determining the overall strength and health of a company. The study of the impact of economic policy uncertainties is important as it could help company and investors in making strategy in investment and also reducing risk. Generally, if a company’s share price increased over time, it shows that the company’s performance is good and the management is doing a great job in meeting targeted achievements. Conversely, a decline in stock price is consider as a poor performance and high risk of a firm. This research paper will explore specifically in the performance of stock in market. There are many factors that could affect the stock performance on the market such as the overall health of the economy which will be explained in details in this paper. Other than that, the condition of the stock market itself and the decrease in demand and the health and performance of the company issuing the stock are also the factor that influence the changes in stock market performance. Stocks will usually face the fall in price during economic downturns as investors will be less active in participating in investments and risk of a stock might increase which could lead to lose. This dissertation’s main objective is to see does economic and policy uncertainties give impact on firm investment and stock market performance. This paper will also explore on the effect of economic policy uncertainties on firm’s investment. F. Pietrovito (2009) paper’s found that the stock market development and the specialization of the financial system towards arm’s length instead of bank financing has a positive effect on firms’ investment decisions. Taken together, these results suggest that firms with higher growth opportunities accumulate more capital and that the stock market has a key role in channelling funds toward investment projects. The study whether economic policy uncertainty has intensified the 2007-2009 recession and weakness recovery has been discussed in recent paper of Baker et al. (2013). Apart from that, this paper objective is also to show how political uncertainties give impact on the stock price. This paper is divided into two categories which are the first part is the empirical base which contain the research on the effect economic policy uncertainty on firm investment and stock market participant. The second part is the literature base research regarding the issue how political uncertainty give impact on stock price. In order to investigate the impact of economic policies and political uncertainties to financial crisis, the impact on stock market and investment decision, I have selected few articles as a guidance in making these dissertation. Those articles and readings are the combination of many scope in policy uncertainties and socks market. They are include the turbulence and uncertainty for the market after the British exit the Europe, measuring economic policy uncertainty, how does political scenario affect the stock market, inflation and inflation uncertainty in the United Kingdom, how political changes affect investors decision and stock market and how this event lead to economic uncertainties and interest rate uncertainty and economy and etc. The literature review on these articles and readings will be written in the first section of this paper. There are a few problems that I have been facing in the early stage of making this dissertation. One of them is the problem in making the research when my ability to interpret the impact of political news on financial markets is constrained by the lack of theoretical guidance. Models in which asset prices respond to political news are notably absent from mainstream finance theory. Other than that, most research that have been done on economic policy and political uncertainty were based in United States. Hence, the references that I could refer to is limited. The data of stock return volatility of United Kingdom and United States are only available up to the year 2015. Hence, the current impact on stock market performance and firm investments due to the changes in policies cannot be analyse and evaluate. My data and investigation year range is 20 years starting from 1995 to 2015. After the analysis of economic policy uncertainty index and volatility of stock price data using OLS regression from Microsoft Words and Eviews Software, the result shows that there positive and negative correlation between these two indexes. The paper proceeds as follows. The methodology and methods are presented in the next section. Data and variables are specified in this section. Econometric issues and empirical results are discussed in section 3. Section 4 offers concluding remarks.
There are a few articles, journals and news that are being discussed in this research paper in order to explore, investigate and find the answer to the research question. This paper main research is related to the economic policy uncertainty. According to that, in the process of understanding the topic of this dissertation, a deliberation on a journal titled ‘Measuring Economic Policy Uncertainty’ written by Scott R. Baker, Nicholas Bloom and Steven J. Davis in The Quarterly Journal of Economics, Volume 131, Issue 4, on 1 November 2016. In this journal, Scott R. Baker, Nicholas Bloom and Steven J. Davis (2009) found the impact of uncertainty to economic. “Federal Open Market Committee (2009) and the International Monetary Fund (IMF) (2012, 2013) suggest that uncertainty about U.S. and European fiscal, regulatory, and monetary policies contributed to a steep economic decline in 2008–2009 and slow recoveries afterward.” (Scott R. Baker, Nicholas Bloom and Steven J. Davis, 2016, p. 1). Other than, Scott R. Baker, Nicholas Bloom and Steven J. Davis (2016) also found out that Bernanke (1983), who points out that high uncertainty gives firms an incentive to delay investment and hiring when investment projects are costly to undo or workers are costly to hire and fire. It is high possibility that in the period when the uncertainties decrease, firms will increase the hiring and investment in order to meet pent-up demand. “The other reasons for a depressive effect of uncertainty include precautionary spending cutbacks by households, upward pressure on the cost of finance (e.g., Pastor and Veronesi 2013; Gilchrist, Sim, and Zakrajsek 2014), managerial risk aversion (e.g., Panousi and Papanikolaou 2012), and interactions between nominal rigidities and search frictions (Basu and Bundick 2012; Leduc and Liu 2015)” (Bloom et al., 2016, p. 2). In the aim to understand inflation uncertainties in United Kingdom, a journal titled ‘Inflation and Inflation Uncertainty in The United Kingdom, Evidence From Garch Modelling’ written by A. Kontonika (2004) is being chosen to study the theoretical logic of how inflation is related to economic policy uncertainty and could lead to the sensitivity of stock market performance and firms’ investment. The author of the journal highlighted that the lower average inflation lead to lower inflation uncertainty with apparent economic benefits. “The idea that a rise in the level of inflation raises uncertainty about future inflation, is central in Friedman’s (1977) Nobel address.” (A. Kontonika, 2004, p. 526). Regarding to that statement, the author said that when inflation is low, policymakers will try to keep it so, thus uncertainty concerning future benefit will so be low. Other than that, policy makers will maximise their own politically motivated aim function that is positively-related to economic stimulation through monetary surprises and negatively-related to monetary growth. As uncertainty about short-run inflation can reflect uncertainty about short-run aggregate demand, which can be influenced by many types of economic policies, thus this makes sense. Monetary policy is more concerned with stabilizing inflation in the longer term. Hassett and Metcalf (1999) in a research paper considering the impact of tax policy uncertainty on firm level investment argue that major changes in tax policy in United Kingdom have changed the cost of capital and returns on capital investment. “The view that tax uncertainty harms investment depends importantly on the irreversibility assumption, and the findings that randomness in output prices retards investment (Pindyck, 1998) in such models” (Hassett and Metcalf, 1999, p. 372). Some firm might invest today to see an Input Tax Credit introduced while some other firms might delay their investment to see an existing Input Tax Credit repealed. Firms will normally use this strategy to reduce the risk of paying tax on output of their business
On top of that topic, the other literature review is about the impact of economic policy uncertainty towards stock market performance. As economic policies change with a high frequency from year to year, a lot of macroeconomist and financial economies explore the role of uncertainty in the real economy and various economic policies in investigating and explaining the significant impact on return in the asset markets. This is because economic policies uncertainty can affect the behaviour and perception of market participants in the good and capital markets. According to Bernanke (1983, p.4) not a purposeful adjustment of stocks to a lower level, investor behaviour during recession is better described as a cautious probing, an avoidance of commitment until the longer run status of both the national economy and the investor’s own fortunes are better known. During the periods of high recession or economic policy in uncertain, Bank may have low confidence and fear in the markets, hence credit availability may become limited. In relation to limited credit availability in bank, a higher cost of finance can be a result of higher risk in the economy as perceived by banks and creditors. Likewise, when uncertainty about future taxes, spending levels, regulations, health-care reform and interest rates is high, consumers and firms have a tendency to postpone spending on investment projects and consumption of goods and services (Baker, Bloom, & Davis, 2012, p. 2). Thorough readings being made on a Journal titled ‘Policy Uncertainty and Private Investment in Developing Countries’ written by Dani Rodrik (1991). The author of the paper mentioned has developed the link to policy uncertainty to the private investment response. However, Rodrik (1991) shows that investment activities are negative correlated with increased policy uncertainty. Driver et al. (2004) research paper compares pooled and non-pooled models of UK capital investment using the Confederation of British Industry’s (CBI) Industrial Trends Survey, focusing on the impact of uncertainty. The results that those authors gain from panel data estimation capture that uncertainty has negative impact on investment. “The uncertainty measure is based on the cross sectional dispersion of optimism about the future business conditions in the industry in which the firm operates” (Driver et al, 2004, p.1). Driver et al. have an opposite results compared to Rodrik (1991) paper. However, “Another study by Rodrik (1991) shows that firms’ delaying of investment is associated with policy uncertainty (Julio and Yook, 2012, p. 46). Furthermore, (Julio and Yook, 2012) also empirically document a negative relationship between political uncertainty and investment activities argued by Sum V (2012, p. 3). Vichet Sum’s (2012) research OLS’s resulted in changes in economic policy uncertainty index predict negative stock returns. Bansal and Yaron (2004, p. 1) suggest that fluctuating economic uncertainty (conditional volatility of consumption) directly affects price–dividend ratios, and a rise in economic uncertainty leads to a fall in asset prices. To the extent that external finance—both through the debt and equity markets—is subject to agency and/or moral hazard problems, an increase in uncertainty will raise the user cost of capital, inducing a decline in investment spending Gilchrist et al.(2010, p. 1). From the reading of various articles and journals, it is found that economic policy uncertainties do and do not impact the stock market performance based on different region, situations and perspective.
‘Political Uncertainty and Risk Premia’ written by Lubos Pastor and Pietro Veronesi. Pastor and Veronesi (2011) mentioned in their article that uncertainty could have a positive effect if the government responds properly to unanticipated shock and the authors also argue that political uncertainty could have a negative effect because it is not fully diversifiable. In the uncertainty of the economic and politic, there are three types of shock that drives the stock prices. They are being called as capital shocks, impact shocks and political shocks. In this paper the investigation would focus more on the stock prices that are driven by the political shocks. Pastor and Veronesi (2013) also said that during weaker economy, the government is more likely to adopt a new policy. Therefore, news about which new policy is likely to be adopted and hence political shocks have a larger impact on stock prices. Moreover, political uncertainty pushes up not only the equity risk premium but also the volatilities and correlations of stock returns (Lubos Pastor and Pietro Veronesi, 2013, p. 4). Apart from political changes, tax uncertainty does effect the asset pricing. “Tax uncertainty also features in Croce, Kung, Nguyen, and Schmid (2012), who explore its asset pricing implications in a production economy with recursive preferences. Croce, Nguyen, and Schmid (2012) examine the effects of fiscal uncertainty on long-term growth when agents facing model uncertainty care about the worst-case scenario.” (Ľuboš Pástor and Pietro Veronesi, 2013, p. 5). During the year 2016, United Kingdom has face a high economic policy and political uncertainties due to the action of British decided to exit from the European Union (BREXIT). A lot of media and news reported the decline in stock price and stock market performance after the announcement of the departure of United Kingdom from the European Union. A literature review from The New York Times titled ‘Trubulence and Uncertainty For The Market After BREXIT’ written by Peter S. Goodman published on June 23, 2016 is being discussed in this paper. During the event when British exit from the European Union, it shocked the global markets. The consequences from the event are the pound plunged to its lowest level since 1985. Picture 1 in this paper shows that the economic policy uncertainty index reach the highest spike during the year 2016 caused by BREXIT. Furthermore, Peter S. Goodman (2016) also reported that investors fled risky assets and turned to the dollar and the yen. The investors to invest in a safer market such in United States and Japan and they also preferred to pull their money out of riskier concerns like stock markets. “The vote could be sign that major democracies are vulnerable to the influence of populist political movements.” (Peter S. Goodman, 2016). Another online newspaper that is being used as reference to the research is the Sky News titled ‘Will the Westminster terror attack have an impact on the economy?’ written by Ian King (2017) who is a business presenter. The author reported that the attacks of 11 September 2001, no such incidents have had any measurable impact on the gross domestic products (GDP) of the economy in which they took place. When GDP have no impact due to the attack, the economic policy uncertainty might only increase by small amount of number or might not affected at all as the attack do not shock the economy. The authors said that the result could be the same whether that be the attacks on London in July 2005, on Madrid in March 2004 or Paris in November 2015 and January 2016. “Perhaps one of the most comprehensive pieces of work done on the economic impact of individual attacks was carried out by the US Government in the aftermath of the 9/11 atrocities” (Ian King, 2017). Based on example from other country such as United States, it is found that New York City lost almost to the amount between $2.5 billion and $2.9 billion in foregone tax revenues as a result of the attacks while New York State lost $2.9 billion. The United States economy had already at a level that start to slow down before the attack, hence the reporter said that the lost is not fully caused by the attack. The study of Jonathan Brogaard and Andrew Detzel (2012) in an article titled ‘The Asset Pricing Implications of Government Economic Policy Uncertainty’ is to find out the relationship between the current levels of economic policy uncertainty and the future market return. “Through a variety of specifications in a simple OLS regression setting, we find a negative contemporaneous correlation between changes in economic policy uncertainty and market returns, and a positive relationship between current levels of economic policy uncertainty and future market returns.”(Jonathan Brogaard and Andrew Detzel, 2012, p. 5). However, Jonathan Brogaard and Andrew Detzel (2012) also found that there is positive shocks to economic policy uncertainty coincide with a decline in prices, but higher future returns. The result from the research shows that economic policy uncertainties have consequences on real asset pricing. Moreover, the impact of economic policy uncertainty on market return or stock performance do not usually happened during the same year. The impact on stock market might take few years from the current year where economic policy is uncertain.
According to Julio and Yook (2012) during the changes in national leadership, if political uncertainty is higher, the elections provide a recurring event that helps isolate the impact of policy uncertainty on investment from other compounding factors. Elections may give bad outcome from a firm’s perspective, the firm may delay investment as they wait until the policy uncertainty is resolved. “The relationship between uncertainty and real investment has been modeled by Bernanke (1983) and Bloom, Bond, and Van Reenen (2007), among others” (Julio and Yook, 2012, p. 2). In Bernanke et al., models show that firms become cautious and hold back on investment in the face of uncertainty. There are more academic people that modelled the effects of political uncertainty in macroeconomic context such as Rodrik (1991) paper shows the uncertainty caused by political changes leads to firm to choose lower investment levels. Julio and Yook (2012) empirical investigation provides that there is strong positive correlation between economic growth and the probability of holding an early elections. Firm’s investment participation have positive relation with economic growth hence there is the net effect on reducing the effect of electoral uncertainty on investment due to the inclusion of timed election. Adam Yonce (2009) empirically found that the decrease in corporate investment rates are associated with policy uncertainties which associated with the possibility of change in government. In investigating how the effect of political uncertainty on investment could give impact on stock price, reading on Durnev (2010) paper is being made. Durnev (2010) paper outcome show that uncertainty happened during elections can affect how corporate investment respond to stock. According to Durnev (2010), during election years compared to non-election years, in elections around the world shows investment is 40% less sensitive to stock prices. This is because the stock prices becoming less informative during elections years as it distract the managers from tracking and follow the changes in price. Furthermore, the author suggest that the drop in investment-to-price sensitivity is larger when election results are less certain, in countries with higher corruption, large state ownership, and weak standards of disclosure by politicians and also suggest that election uncertainty leads to inefficient capital allocation, reducing company performance. As economic policy uncertainty include the respond to news, political uncertainty could also give impact on stock market performance when the company performance is reduced. Moreover, in the research paper of Belo et al. (2011), the authors suggest that returns are higher few years after the presidential term when political uncertainty during the election and it is associated the government spending policy have been resolved. Apart from the uncertainties itself, there are other factor that could increase the sensitivity of firm stock and market stock. “The finding of large abnormal returns can also be interpreted as evidence of a missing risk factor; it may be that firms with higher exposure to government spending are firms with higher sensitivity to a latent political risk factor” (Belo et al., 2011, p. 28). In the deep study of correlation of political uncertainties such as during election and presidential season, Santa Clara and Rossen Valkon (2003) paper documented the excess returns correlate with presidential-partisan cycles. According to the authors, the found that the presidential cycle variables encapsulate the information about returns that is not correlated with business cycles variables. The finding could show that business performance and firm stock return might not be affected due to the election of new president which oppose the finding of Belo et al. (2011). Again there is a research paper that also discover that there is no relation of political uncertainty or political cycle and firm’s investment. Referring to the work of Adam Yonce (2009), after controlling for endogenous cash flows and potential auto correlation in the error term, the author argue that the investment for the sample of firms being investigated appears to have no relationship with political cycle, outside of effects associated with the fiscal environment.
Further reading have been made on political instability and the article titled is ‘Does Political Instability in Developing Countries Affect Foreign Investment Flow’ written by Mario Levis. The decrease of investment flow from the United States to Latin could be attributed to different accounting procedures and different investment strategies, but the investors’ fear of an epidemic political turmoil all over Latin America seemed to be a major factor. Mario Levis wrote that Basi and Aharon conclude that political risk is a major determinant in foreign investment decisions, Piper seems to doubt it. “Basi’s second study, based on a mail survey of more than 300 international executives, found that a nation’s level of political instability and the extent of its market potential are the two most important factors in foreign investment decisions”. (Mario Levis, 1979). However, there is a contrast opinion from the Green and Cunningham10. From a study based on 25 nations they indicate that political in- stability was found not to be significantly related to foreign investment, while measures of market potential are the most important determinants of the allocation of US foreign investment.
To understand and explain the study of impact on changes in economy policy on stock market performance and firm’s investment, this paper collect data of economic policy uncertainty index and the volatility of stock price in United Kingdom and United States and use Microsoft Excel regression and Eviews regression to see the relations. Santa Clara and Rossen Valkon (2003) investigation found that there is no evidence of large excess return around election dates and also volatility is to some extent higher in Republican presidencies.
3. METHOD AND DATA
The data of Economic Policy Uncertainty Index of United Kingdom and United States are being used in this research paper. The data of economic policy uncertainty index of United Kingdom is obtain from Federal Reserve Economic Data (FRED) while the economic policy uncertainty index of United States have been collected from a website which is www.policyuncertainty.com. This website provides monthly data of economic policy uncertainty index from all around the world and the researchers are Scott R. Baker, Nick Bloom and Steven J. Davis. In relation to find the impact of economic policy uncertainty on stock market performance and firm’s investment, data on stock volatility of both countries, United Kingdom and United States, are obtain from Federal Reserve Economic Data (FRED). All of the data are being evaluate and analyse in annually period. In addition, Microsoft Excel is being used to create a regression on these data related to the finding of the effect of economic policy uncertainty on stock market performance. The investigation on relation of economic policy uncertainty and firm’s investment is being made by using Eviews software. There is no specific data and evaluation on the impact of political changes on stock prices. However, the economic policy uncertainty index components include the news which consider it is from government.
The OLS regression (Equation 1) is being employed to analyse the data regarding the study of the economic policy uncertainty and stock performance in United Kingdom and United States. While for the study of economic policy uncertainty and firm investment, OLS regression (Equation 2) is being employed.
Rt = return on the stock market index in month t
∆EPUt= change in the index of economic policy uncertainty index in month t less month t-1
Rt= α + βEPU + εt
2.2 Economic policy uncertainty and components
The developers of Economic Policy Uncertainty index are Baker, Bloom and Davis (2012). Baker et al.’s (2013) overall index of economic policy uncertainty is a weighted average of four uncertainty components which are the new-based policy uncertainty, Consumer Price Index forecast interquartile range, tax legislation expiration and federal expenditure forecast interquartile range (denoted by news uncertainty, CPI disagreement, taxation expiration, and expenditure dispersion, respectively). The uncertainty of the news represent newspaper that writes about the economic policy uncertainty. It is constructed by month to month searches of 10 large newspaper for articles containing words relating to uncertainty, economic/economy, monetary and fiscal policies and one or more of congress, deficit, Federal Reserve, legislation or White House. There are four steps taken by Baker et al. in overcoming the issue address in the approach to measuring policy uncertainty. The first step is Baker et al. show a strong relationship between their measure of economic policy uncertainty and other measure of economic uncertainty for example they implied stock market volatility. The next step is they compare the index to other measure of policy uncertainty such as the frequency with which the Federal Reserve System’s Beige Books mention policy uncertainty. Third they find similar movements in EPU indices based on right-leaning and left-leaning newspaper and the last one is they conduct an extensive audit study randomly selected articles drawn from major United States newspapers.
4 EMPIRICAL RESULTS
4.1 Economic policy uncertainty and stock return volatility in United Kingdom
Summary output above is the regression from data related to the change in economic policy uncertainty index (t – t-1) and the stock return volatility in United Kingdom. The R Square represent the percent of the variance of the output variables in economic policy uncertainties index does explain by the variance of the input variables, the stock return volatility. In this case the R Square is shows that there is more than 2% relation between these two variables.
The p-value shows that 50% chance that the coefficient is obtain by chance. Apart from that the coefficient, as shown in table is positive coefficient and statistically significant.
Rt= α + βEPU + εt
The beta coefficient is the degree of change in the outcome variable for every 1-unit of change in the predictor variable. If the beta coefficient is positive, the interpretation is that for every 1-unit increase in the predictor variable, the outcome variable will increase by the beta coefficient value. If the beta coefficient is negative, the interpretation is that for every 1-unit increase in the predictor variable, the outcome variable will decrease by the beta coefficient value. So in this case, for every 1% change in the economic policy uncertainty index, it is expected that the stock return volatility to increase by 0.02%.
4.2 Economic policy uncertainty and stock return volatility in United States
Summary output above is the regression from data related to the change in economic policy uncertainty index (t – t-1) and the stock return volatility in United States. The R Square represent the percent of the variance of the output variables in economic policy uncertainties index does explain by the variance of the input variables, the stock return volatility. In this case the R Square is shows that there is 0.005% relation between these two variables.
The p-value shows that more than 78% chance that the coefficient is obtain by chance. Apart from that the coefficient, as shown in table is negative coefficient and statistically significant.
Rt= α + βEPU + εt
The Beta for this regression is negative In the case of relation between economic uncertainty index and stock return volatility in United States, for every 1% change in the economic policy uncertainty index, it is expected that the stock return volatility to decrease by -0.017.
4.3 Effect of economic policy uncertainty on firm investment in United States
Rt= α + βEPU + εt
The Beta for this regression is positive. Hence in this study, of relation between economic uncertainty index and firm investment in United Kingdom, for every 1% change in the economic policy uncertainty index, it is expected that the stock return volatility to increase by 3.4813.
4.4 Effect of economic policy uncertainty on firm investment in United Kingdom
For the study of economic policy uncertainty index and firm investment in United States, the coefficient shows a positive values which indicate the Beta is positive. For every 1% change in economic policy uncertainty in United States, it expected that the stock return volatility to increase by 3.8201.
Based on the results shown above, I can evaluate that for both countries, United Kingdom and United States, the stock return volatility will increase due to the uncertainty of economic policy. Based on the results from stock return volatility, this paper shows how economic policy uncertainty effects the stock market performance, firm’s investment and stock price as stock return is one of the main indicator in determining the stock market performance, firms investment and stock price of a market. However, the result for the effect of economic policy uncertainty on stock performance in United States shows that it does not affected by the changes. This might be because some other factors such as the investment is being made after the uncertainty is being resolved or the during the turbulence of economy, there are other factor that could distract the investors and company’s managers from taking action that could affect the stock performance and firm’s investment.
Apart from the regression results, the above graphs could show if stock is effected by the economic policy uncertainty by comparing the movement of economic policy uncertainty index and the movement of the volatility of stock price from year to year. These two graph above are based in United Kingdom data and is taken from Federal Reserve Economic Data (FRED). The changing pattern on both graphs are highly correlated. In the year in between 2002 and 2004, 2010 and 2012 and during the year close to 2012, both graphs shows spikes at almost the same year. During the year 2004 to 2006, economic policy uncertainty is low and the volatility of stock price index during the period show a trough. The higher/lower the economic policy uncertainty index, the higher/lower the volatility of stock price and this could result to the higher/lower the stock market performance and firm’s investment.
Moving on to the graphs of economic policy uncertainty index and volatility of stock price index in United States. Same goes to these two graphs, the changes in these graphs are highly correlated. During the year in between 2002 and 2004 and between 2008 and 2010, the graphs show spikes while in the year between 2004 and 2008, both graphs constantly at a low level. These shows that the increase/decrease in economic policy uncertainty in United States will also increase/decrease the volatility of stock price in United States. The relation of stock market performance and firm’s investment with the economic policy uncertainty can be shown through the volatility of stock price index.
“We find that the number of large movements in the S&P 500 index, defined as a daily change of 2.5% or more, has increased dramatically in recent years relative to the average since 1980.
Moreover, since 2008, an increasingly large share of these large stock movements have been caused by policy-related events” (Bloom et. al, 2012).
The graph shows that during the year 2008 and onward levels of economic policy uncertainty are at the highest level compared to the previous years.
Bloom et al. (2015) shows that there is relationship between their economic policy uncertainty and real macroeconomic variables. The graph shows that an increase in economic policy uncertainty foreshadows a decline in economic growth and employment in the following months.
In conclusion, based on the articles, journals and news that I have read. Most of the research mention that there is impact on financial crisis, asset prising, investors’ decision and stock market from economic policy and political uncertainties. However, there are also academic research paper that produce evidence that in certain situations, cases and limits, there will be no impact or less impact of stock when the economic policy is uncertain. Based on my empirical results on the research of the relation between economic policy uncertainty and stock market performance and firm’s investment, it is found that there is the positive relation of economic policy uncertainty and the volatility of stock price in both countries which are United Kingdom and United states. These results indicates that the increase in economic policy uncertainty in both countries, the firm’s investment level is affected and being reduced. The output results on the study of the relation between economic policy uncertainty and stock market performance for United Kingdom and United States are difference. The OLS regression for the investigation of United Kingdom’s data show a positive relation while for United States shows a negative relation. It demonstrate that stock market performance is better during a high economic policy uncertainty periods. This situation can be explained by the paper of Jonathan Brogaard and Andrew Detzel (2012) which argue that they find a negative contemporaneous correlation between changes in economic policy uncertainty and market returns, and a positive relationship between current levels of economic policy uncertainty and the future market returns through a variety of specifications in a simple OLS regression setting. Aside from that, the delay of investment could be one of the factors that cause the negative contemporaneous correlation between changes in economic policy uncertainty and market returns. While some other academic researchers are also found that economic policy uncertainty in positively related to firm investment. Vichet Sum’s (2012) research OLS’s resulted in changes in economic policy uncertainty index predict negative stock returns.
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