Economic Policy Uncertainty and the Swedish stock market : A quantitative study on how Economic Policy Uncertainty affects the Swedish stock market

Abstract: This study examines the effect of Economic Policy Uncertainty (EPU) on the Swedish stock market, both in the short-run and the long-run. To do this, the Economic Policy Uncertainty index, developed by Armelius et al. (2016), is used. This index was constructed with the purpose of measuring uncertainty related to economic policy. EPU may make firms postpone important investments or decisions which could affect financial outcomes and cash flow in the future. As future cash flows are often correlated with the stock prices, this may put downward pressure on the price (Gulen & Ion, 2014). EPU may also affect the factors determining discount rates, such as interest rates, inflation, and risk premiums (Pastor and Veronesi, 2013). The results in this study may help investors and large institutions to understand how stocks are priced during times of economic policy uncertainty. Also, if the effect of the EPU is significantly negative, it will give authorities and the government an incentive to maintain transparency to make the markets less volatile. Earlier studies suggest that EPU has a negative effect on stock market returns in several countries such as Australia, Canada, China, Japan, Korea, and the US (Arouri et al., 2016 & Christou et al., 2017). The findings in this study suggest that EPU has a negative effect on the Swedish stock market in the short run. The effect is greatest during the same month the uncertainty shock occurs. During the first and second month after, the effect is still negative, but smaller. However, when analysing possible cointegration among the variables in the model them, no long-run relationship can be found between EPU and the stock market index.