Fiscal Policies and Asset Prices

Abstract

The surge in public debt triggered by the financial crisis has raised uncertainty about future tax pressure and economic activity. We examine the asset pricing effects of fiscal policies in a production-based general equilibrium model in which taxation affects corporate decisions by: (1) distorting profits and investment; (2) reducing the cost of debt through a tax shield; and (3) depressing productivity growth. In settings with recursive preferences, these three tax-based channels generate sizable risk premia, making tax uncertainty a first-order concern. We document further that corporate tax smoothing can substantially alter the effects of public expenditure shocks. AbstractThe surge in public debt triggered by the financial crisis has raised uncertainty about future tax pressure and economic activity. We examine the asset pricing effects of fiscal policies in a production-based general equilibrium model in which taxation affects corporate decisions by: i) distorting profits and investment; ii) reducing the cost of debt through a tax shield; and iii) depressing productivity growth. In settings with recursive preferences, these three tax-based channels generate sizable risk premia making tax uncertainty a first order concern.We document further that corporate tax smoothing can substantially alter the effects of public expenditure shocks.

Innovation Dynamics and Fiscal Policy: Implications for Growth, Asset Prices, and Welfare

“…Overall, we contribute to this literature by quantifying the eects of sector-specic policies on welfare, growth, and asset prices in the presence of either vertical or horizontal innovations. In this respect, our paper is additionally connected to the most recent endogenous growth-based asset pricing literature (Kung and Schmid, 2015) and studies examining the eects of scal and monetary policies on asset prices (Croce, Kung, Nguyen, and Schmid, 2012;Gomes, Michaelides, and Polkovnichenko, 2013;Horvath, Kaszab, and Mar²ál, 2016). Kung and Schmid (2015) point out that long-term growth prospects are endogenously determined by innovation and R&D. Specically, investment in R&D endogenously drives a small and persistent component in aggregate productivity.…”

“…Donadelli and Grüning (2016) show that the inclusion of endogenous labor dynamics and labor market frictions in the Kung and Schmid (2015) economy further increases long-run uncertainty and risk premia. Croce, Kung, Nguyen, and Schmid (2012) build a production-based economy with exogenous shocks to public expenditure. Their quantitative results suggest that both volatility and the intertemporal distribution of tax rates directly aect the cost of equity and capital accumulation.…”

Government spending, political cycles, and the cross section of stock returns

“…Relatively few papers have studied the relationship between government policies and asset prices. Theoretical contributions include Pastor and Veronesi (2011a), Gomes, Michaelides, and Polkovnichenko (2010), and Croce, Kung, Nguyen, and Schmid (2011); while empirical contributions can be found in Santa-Clara and Valkanov (2003), Tavares and Valkanov (2003) and Boutchkova, Doshi, Durnev, and Molchanov (2011). In this paper, we exploit a novel measure of exposure to the government sector and the time-series variation in the cross-section of stock returns to identify the impact of government spending policies over political cycles on stock returns.…”

Divided governments and futures prices

“…Sialm (2006) studies the effect of stochastic taxes on asset prices in a dynamic general equilibrium model. In a similar spirit, Croce et al (2012) investigate the asset pricing implication of tax uncertainty in a production economy. Considering a broader set of government actions, Pástor and Veronesi (2012) theoretically explore how changes in government policy affect stock prices and analyze how the stock market reacts to government's policy decisions.…”