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The IUP Journal of Applied Finance

Impact of Economic Policy Uncertainty on Stock Market Returns and Turnover: A VAR Analysis

Article Details

Pub. Date	: July, 2023
Product Name	: The IUP Journal of Applied Finance
Product Type	: Article
Product Code	: IJAF010723
Author Name	: Devika Dileep Kumar
Availability	: YES
Subject/Domain	: Finance
Download Format	: PDF Format
No. of Pages	: 10

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Abstract

Economic Policy Uncertainty (EPU) and stock market mechanisms received much attention after the 2007-2008 Global Financial Crisis. Uncertainty can influence significant economic variables through different channels. The paper uses a univariate VAR model to analyze how EPU was affected by stock market returns and turnover from January 2009 to December 2019. The analysis uses data from BSE. The EPU index formulated by Baker et al. (2016) is used to analyze the level of uncertainty across policy implications. The results show that market turnover responds negatively towards EPU. At the same time, no relationship exists between stock returns and EPU.

Introduction

Many studies on stock market volatility and Economic Policy Uncertainty (EPU) have shown how certain macroeconomic variables like economic growth, inflation, investment, employment, etc., are influenced (Fernandez-Villaverde et al., 2014). Relative to the existing studies, less attention is paid to stock market performance and EPU. The results from the very few studies existing in this particular area define a negative relationship between the stock market and policy uncertainty (Bayar and Aytemiz, 2015; Phan et al., 2018; and Xiong et al., 2018). Some of the relevant results shown by Antonakakis et al. (2013), Brogaard and Detzel (2015), Kang and Ratti (2015), Bloom (2009) and Liu and Zhang (2015) highlight the impact of uncertainty shocks on stock market performance. Uncertainty might negatively affect the economic variables through different channels. First, policy uncertainty within the decision-making process causes delays over important decisions taken by firms and other economic units (Bonaime et al., 2018); second, uncertainty might increase financing and production cost, which may affect both the demand and supply sides (Hranaiova and Stefanou, 2002); third, it increases financial risk and also reduces the value of protection (Pastor and Veronesi, 2012). Looking from the demand side, economic uncertainty reduces the investment level of firms which leads to delay in the completion of projects (Bernanke, 1983; McDonald and Siegel, 1986; and Dixit and Pindyck, 1994), while on the supply side, the hiring plan and investment pattern of firms might be affected through higher level of economic uncertainty within the firm and across the economy. Some studies emphasize financial risk and policy uncertainty perplexion among policymakers, investors and portfolio managers. Studies by Kang and Ratti (2013), Antonakakis et al. (2014), Brogaard and Detzel (2015), and Arouri et al. (2016) explore the relationship between stock market and the oil market. Yuan et al. (2022) emphasize that uncertainty-induced stock market shocks reflect their impact on