Economic policy uncertainty, CDS spreads, and CDS liquidity provision

Wang, Xinjie; Xu, Weike; Zhong, Zhaodong

doi:10.1002/fut.21982

Cited by 62 publications

(20 citation statements)

References 63 publications

(131 reference statements)

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“…This is largely borne out by the empirical evidence for US stocks (Alexopoulos and Cohen, 2015;Antonakakis et al, 2013;Arouri et al, 2016;Brogaard and Detzel, 2015) and international stocks (Brogaard et al, 2020;Chen et al, 2017;Christou et al, 2017, Chiang, 2019Helseth et al, 2020;Ko and Lee, 2015;Liu and Zhang, 2015;Phan et al, 2018;Smales, 2020;Sum, 2013;Tsai, 2017). There is also more limited evidence of US bond markets exhibiting wider default spreads (Pastor and Veronesi, 2013;Wang et al, 2019;Wisniewski and Lambe, 2015) and currency markets displaying higher volatility (Bartsch, 2019;Kido, 2016;Krol, 2014) in the presence of increased US policy uncertainty.…”

Section: Introductionmentioning

confidence: 99%

Policy uncertainty in Australian financial markets

Smales

2020

Australian Journal of Management

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Economic policy touches most facets of corporate decision-making and variations in policy can elicit significant changes in financial performance and asset prices. We utilize the economic policy uncertainty (EPU) measure of Baker et al. to investigate the extent to which policy uncertainty influences Australian financial market returns. Our empirical results demonstrate that both domestic and global uncertainty have a significant negative impact on excess stock returns, changes in bond yields and Australian dollar (AUD) returns. The relationship is concentrated in the left tail of the return distribution and largely driven by increases in policy uncertainty. Although the identified relationship is negative throughout the sample period, the magnitude of the relationship appears to be state dependent and is influenced by periods of high uncertainty, recession and the lead-up to federal elections. The most plausible explanation for our results is that uncertainty about economic policy is channelled to financial markets via the discount rate effect, resulting in a higher risk premium. Our results are important for investors, corporate managers and policy makers wishing to navigate periods of policy uncertainty. JEL Classification: G10, G12, G14, G15

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Section: Introductionmentioning

confidence: 99%

Policy uncertainty in Australian financial markets

Smales

2020

Australian Journal of Management

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“…Liu and Zhong () and Wang et al . () also focus on the link between political uncertainty and credit risk. Unlike Kaviani et al .…”

Section: Political Uncertainty and Asset Pricesmentioning

confidence: 99%

“…Wang et al . () employ the political uncertainty index of Baker et al . (), and document similar evidence that increases in the uncertainty index lead to increases in the CDS spreads, and the impacts can persist for up to eight quarters.…”

Section: Political Uncertainty and Asset Pricesmentioning

confidence: 99%

Political Uncertainty and Finance: A Survey

Dai

Zhang

2019

Asia-Pac J of Fin Stud

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An emerging stream of literature investigates the impact of political uncertainty on financial markets. In this survey, we review this line of literature from four perspectives, namely, asset prices, corporate policies, financial intermediaries, and economy and households, suggesting that political uncertainty generally increases market friction and as a result changes corporate behavior and adversely affects the economy. At the end of the survey, we discuss a few future directions worth being explored in view of the relationship between political uncertainty and finance. most likely to occur if the old policy has led to unexpected low realized profitability. Therefore, policy change can increase firms' expected profitability, thereby pushing stock prices up, that is, the cash flow effect. However, due to the new policy's higher uncertainty, policy change can also increase discount rates, thereby pushing stock prices down, that is, the discount rate effect. The authors show analytically that, on average, the discount rate effect will outweigh the cash flow effect and stock prices will fall at the announcement of a government policy change. The reason is that positive announcement returns tend to be small as policy changes that have the potential to push stock prices up are mostly expected by investors. Moreover, as new policies introduce more uncertainty and raise the volatility of the stochastic discount factor, government policy changes will increase stock return volatilities and correlations.Closely related to P astor and Veronesi (2012, 2013) analyze the risk premium induced by political uncertainty. P astor and Veronesi (2013) extend the general equilibrium model developed by P astor and Veronesi (2012) in two key aspects. First, unlike P astor and Veronesi (2012) who assume political cost is unknown to investors, P astor and Veronesi (2013) allow investors to learn about the political costs of the new policies through the stream of political news. Second, P astor and Veronesi (2012) assume that all government policies are identical a priori, whereas P astor and Veronesi (2013) allow the government to choose from a set of heterogeneous policies. The impacts of both, the learning about political costs and policy heterogeneity, are larger in weak economic conditions when a policy change is more likely to happen.Accordingly, in P astor and Veronesi's (2013) analytic model, stock returns are driven by capital shocks, impact shocks, and political shocks, and correspondingly the equity risk premium can be decomposed into three components based on the three types of shocks. As the optimal choice for the government is to change its policy when the old policy is perceived as sufficiently unfavorable, the authors show analytically that the composition of the risk premium varies depending on the economic state. In weak economic conditions when the probability of a policy change is high, the equity risk premium is largely driven by the political risk premium. However, in strong economic conditions when a policy change ...

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“…Baker, Bloom, and Davis () show that uncertainty about economic policy tends to precede declines in investment and output. Wang, Xu, and Zhong () examine the effect of economic policy uncertainty on CDS spreads.…”

Section: Introductionmentioning

confidence: 99%

Oil price volatility and real options: 35 years of evidence

Elder

2019

Journal of Futures Markets

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There has been a surge in interest in the effects of uncertainty on investment decisions, motivated at least in part by the theory of real options. For example, Bloom (2009, Econometrica, 77, 623–685) shows that higher uncertainty causes firms to temporarily pause investment and hiring, generating sharp economic downturns. This paper investigates these effects by examining the response of disaggregated measures of production to volatility in oil prices. We find that increased oil price volatility has strong negative effects on the production of durable goods, such as transportation equipment, and oil exploration, such as the drilling of oil and gas wells.

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Economic policy uncertainty, CDS spreads, and CDS liquidity provision

Cited by 62 publications

References 63 publications

Policy uncertainty in Australian financial markets

Policy uncertainty in Australian financial markets

Political Uncertainty and Finance: A Survey

Oil price volatility and real options: 35 years of evidence

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