Navigating Uncertainty: A Study on the Impact of Policy Uncertainty on Stock Returns, Firm Investment, and Investor Sentiment in the United States

Abstract: We investigate how US policy uncertainty is related to US stock returns, firm investments, and investor sentiment - in order to shed light on the responses made by firms and investors when faced with higher uncertainty. Leveraging the economic policy uncertainty index, we find that policy uncertainty is negatively correlated with US stock returns in the same month following a shock to uncertainty, and propose evidence that points towards policy uncertainty potentially being a source of return predictability in the US. Our results also point towards policy uncertainty having effects on the demand for downside protection by looking at how investors respond to shocks in uncertainty, but find no conclusive evidence regarding its effects on market wide investor sentiment. We find a delayed and negative impact on firm investment, implying that policy uncertainty could have an impact on firms' investment decisions as they defer investments in favor of waiting for more information.