How Does Policy Uncertainty Influence Financial Market Uncertainty Across the G7?

Economic policy uncertainty (EPU) relates to ambiguity surrounding possible changes in government policy and their associate impact on firm performance. This uncertainty places additional stress on economic agents and has implications for the global economy via delays in firm investment and hiring, and postponement of household consumption. We utilise the EPU measure of Baker et al. (2016) to investigate whether financial market uncertainty is influenced by policy uncertainty across the G7. Our empirical results show that financial market uncertainty (implied volatility) increases as economic policy uncertainty increases (and the economy weakens). This relationship holds even after controlling for macroeconomic state variables and country/time fixed effects, and is consistent for monthly and daily data frequency. The correlation of political uncertainty among countries varies over time, increasing in tranquil times of low EPU, and sharply decreasing during times of crisis. We also show that US policy uncertainty has an economic and statistically significant impact on global financial market uncertainty, a spill-over effect that is consistent with the important role that US policy decisions play in the global economy