Economic policy uncertainty and stock market in G7 Countries: A panel threshold effect perspective

Abstract

Based on the literature, it is commonly understood that stock prices (SP) are influenced by economic policy uncertainty (PU), with a rise in PU typically having a negative impact on SP. However, the relationship between PU and SP may not always be linear due to the varying risk preferences of individuals. Risk preference theory posits that individuals respond differently to different levels of risk. Therefore, this study aims to investigate whether PU determines SP asymmetrically (i.e., in a non-linear manner) by considering risk preferences and addressing a gap in the literature. To answer this question, the study employs a panel threshold approach to examine the effect of PU on SP in the Group of Seven (G7) countries, namely Canada, France, Germany, Italy, Japan, UK, and the US. In contrast to previous research, this study finds evidence of an asymmetric effect of PU on SP in the G7 countries. Specifically, the panel threshold results reveal that the impact of increased PU on SP is positive up to a certain level (Threshold1), beyond which it becomes negative (Threshold2). These findings are in line with information asymmetry hypothesis, prospect theory, behavioural finance hypothesis, and market liquidity hypothesis and shed light on the asymmetric behaviour of SP in response to varying levels of PU. The implications of these findings are significant for understanding how to manage risks effectively in the financial markets.

Effect of Economic Policy Uncertainty on China’s Stock Price Index: A Comprehensive Analysis Using Wavelet Coherence Approach

“…This aligns with the conclusions drawn from wavelet causality analysis, where mutual causation is evident at varying frequency levels. While a corpus of scholarly research underscores the influence of government economic policies on stock market volatility and firm fundamentals (Arouri & Roubaud, 2016;Chen et al, 2017;Drobetz et al, 2018;He & Niu, 2018;Hussain et al, 2020;Jory et al, 2020;Khan et al, 2020;Khojah et al, 2023;Wu et al, 2022), our findings present a nuanced perspective. In line with the limited empirical evidence for example, Arouri and Roubaud (2016) who identified an insignificant impact of EPU on Chinese stocks through time series regression analysis.…”