How Does Policy Uncertainty Affect Investments?

In this episode, university professors Kate Holland and Veljko Fotak explore academic research on the impact of policy uncertainty on investment decisions, markets, and firms. The episode underscores that high levels of policy uncertainty tend to depress corporate investment, hiring, and economic growth, as firms delay major expenditures. The conversation spans equity markets and higher risk premia, as well as 'flight to safety' effects in bond markets and the crucial question: Why are markets seemingly not reacting to the high levels of uncertainty in the summer of 2025?

Timeline:

00:00 How Does Policy Uncertainty Affect Investments?

06:01 Welcome to Questions in Finance

06:39 Defining and Measuring Policy Uncertainty

07:45 Economic Policy Uncertainty Index (EPU)

11:53 Historical Context and Validation of the EPU

16:47 Corporate Reactions to Policy Uncertainty

24:08 Impact on Mergers and Acquisitions

26:14 Research and Development During Uncertainty

30:14 Policy Uncertainty and Equity Markets

38:00 What is NOT Happening in 2025

47:42 Uncertainty and Bond Markets

49:39 Flight to Safety Mechanism

58:10 Political Uncertainty and Option Markets

59:06 Summary and Final Thoughts

Bibliography:

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Azzimonti, Marina. "Partisan conflict and private investment." Journal of Monetary Economics 93 (2018): 114-131.

Baker, Scott R., Nicholas Bloom, and Steven J. Davis. "Measuring economic policy uncertainty." The Quarterly Journal of Economics 131, no. 4 (2016): 1593-1636.

Bianconi, Marcelo, Federico Esposito, and Marco Sammon. "Trade policy uncertainty and stock returns." Journal of International Money and Finance 119 (2021): 102492.

Bonaime, Alice, Huseyin Gulen, and Mihai Ion. "Does policy uncertainty affect mergers and acquisitions?." Journal of Financial Economics 129, no. 3 (2018): 531-558.

Boutchkova, Maria, Hitesh Doshi, Art Durnev, and Alexander Molchanov. "Precarious politics and return volatility." The Review of Financial Studies 25, no. 4 (2012): 1111-1154.

Brogaard, Jonathan, and Andrew Detzel. "The asset-pricing implications of government economic policy uncertainty." Management science 61, no. 1 (2015): 3-18.

Gulen, Huseyin, and Mihai Ion. "Policy uncertainty and corporate investment." The Review of Financial Studies 29, no. 3 (2016): 523-564.

Hassan, Tarek A., Stephan Hollander, Laurence Van Lent, and Ahmed Tahoun. "Firm-level political risk: Measurement and effects." The quarterly journal of economics 134, no. 4 (2019): 2135-2202.

Julio, Brandon, and Youngsuk Yook. "Political uncertainty and corporate investment cycles." The Journal of Finance 67, no. 1 (2012): 45-83.

Kelly, Bryan, Ľuboš Pástor, and Pietro Veronesi. "The price of political uncertainty: Theory and evidence from the option market." The Journal of Finance 71, no. 5 (2016): 2417-2480.

Leippold, Markus, and Felix Matthys. "Economic policy uncertainty and the yield curve." Review of Finance 26, no. 4 (2022): 751-797.

Nguyen, Nam H., and Hieu V. Phan. "Policy uncertainty and mergers and acquisitions." Journal of Financial and Quantitative Analysis 52, no. 2 (2017): 613-644.

Pastor, Lubos, and Pietro Veronesi. "Uncertainty about government policy and stock prices." The Journal of Finance 67, no. 4 (2012): 1219-1264.

Pástor, Ľuboš, and Pietro Veronesi. "Political uncertainty and risk premia." Journal of Financial Economics 110, no. 3 (2013): 520-545.

Wang, Junbo, Chunchi Wu, Xiaoguang Yang, and Ye Zhou. "Policy uncertainty and corporate bond issuance costs." Review of Quantitative Finance and Accounting (2025): 1-42.

Soundtrack:

The soundtrack is based on "Walk on a Funky Street" by MondayHopes. Thanks for the music and keep up the good work! Use is under the Pixabay Content License.