The purpose of this study is to examine the bi-directional causality between political uncertainty and the market risk premium in the US.
I use a theoretical model to motivate signs and then check signs based on a vector autoregression.
I find that political uncertainty has a small positive, delayed effect on the market risk premium. The market risk premium, on the other hand, has a large permanent, negative effect on political uncertainty.
This is the first research paper to consider the bi-directional effects of political uncertainty on the market risk premium and vice versa. It also finds interesting empirical results.
The author would like to acknowledge the contributions of an anonymous referee. No funding was received by the author for this research.
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