# Economic Policy Uncertainty and Stock Return Momentum

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## Abstract

**:**

## 1. Introduction

## 2. Literature Review

#### 2.1. Business Cycle

#### 2.2. Market State

#### 2.3. Macroeconomic Risk

#### 2.4. Economic Policy Uncertainty

## 3. Methodology

_{t}= α + β

_{1}MKTRF

_{t}+ β

_{2}SMB

_{t}+ β

_{3}HML

_{t}+ β

_{4}WML

_{t}+ ε

_{t}

_{t}is the excess return on either a long, short or hedge portfolio at the end of the month t, MKTRF

_{t}is the “value-weighted market excess return” at the end of the month t, while SMB

_{t}is the return “spread between small and big size stocks” at month t. HML

_{t}is the return differential between “high and low book to market value stocks” at month t, and WML

_{t}is the return differential between the “winner and loser stock” for month t. ε

_{t}is the error term at month t.

_{t}= α

_{h,t}β

_{h}+ α

_{l,t}β

_{l}+ β

_{1}MKTRF

_{t}+ β

_{2}SMB

_{t}+ β

_{3}HMLt + β

_{4}WML

_{t}+ ε

_{t}

_{h,t}and α

_{l,t}are the dummy variables to classify high and low EPU periods, respectively, while R

_{t}, MKTRF

_{t}, SMB

_{t}, HML

_{t}, and WML

_{t}are the same as described in Equation (1).

_{t}= α + β

_{1}EPU

_{t−1}+ ε

_{t}

_{t}= α + β

_{1}EPU

_{t−1}+ β

_{2}MKTRF

_{t}+ β

_{3}SMB

_{t}+ β

_{4}HML

_{t}+ β

_{5}WML

_{t}+ ε

_{t}

_{t}, MKTRF

_{t}, SMB

_{t}, HML

_{t}, and WML

_{t}are the same as described in Equation (1).

_{t}= α + β

_{1}DIV

_{t−1}+ β

_{2}INFLATION

_{t−1}+ β

_{3}M3

_{t−1}+ β

_{4}YIELD

_{t−1}+ β

_{5}DEFAULT

_{t−1}+

β

_{6}TERM

_{t−1}+ β

_{7}IIP

_{t−1}+ β

_{8}EPU

_{t−1}+ ε

_{t}

_{t−1}is the dividend yield at the end of month t − 1, INFLATION

_{t−1}is the rate of consumer price index at the end of month t − 1, M3

_{t−1}is the money supply for month t − 1, YIELD

_{t−1}is the yield on three month treasury bill for month t − 1, DEFAULT

_{t−1}is the default spread at the month t − 1, TERM

_{t−1}is the term spread for month t − 1, I IP

_{t−1}is the level of industrial production for month t − 1, EPU

_{t−1}is the EPU index value at the end of month t − 1, and ε

_{t}is the error term.

## 4. Data and Variables

## 5. Empirical Findings and Interpretation

#### 5.1. Descriptive Statistics

#### 5.2. Business Cycle and Momentum

#### 5.3. Four Factors Alpha and GRS Test

#### 5.4. Portfolio Sorting of EPU and Momentum

#### 5.5. Time Series Regression of Momentum and EPU

#### 5.6. Macroeconomic Variables

#### 5.7. Time Series Evidence

#### 5.7.1. Selection Order Criteria for Lags

#### 5.7.2. VAR Model

#### 5.7.3. Vector Error Correction Model

#### 5.7.4. Impulse Response

## 6. Conclusions

## Author Contributions

## Funding

## Data Availability Statement

## Conflicts of Interest

## References

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1 | The first component comprises search results gathered from 10 leading newspapers daily in the United States, where newspaper articles deliberating over economic policy are incorporated. An article is associated with economic uncertainty when words such as ‘uncertain,’ ‘economic,’ ‘legislation,’ and ‘federal reserve’ have be used at least once in the newspaper article. The second component is created by the inclusion of “tax code provisions” that are slated to elapse over the coming 10 years. The last component collects data from “Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters” to compute the level of dispersion among individual forecasters relating to macroeconomic policy variables. The weights assigned to the first, second, and third components are 0.5, 0.17, and 0.33, respectively. |

2 | For example, Jegadeesh and Titman (2001) using a sample of NASDAQ, NYSE, and AMEX listed stocks from 1990–1998, documented that past winners outperform past losers by approximately 1.39% per month. This is consistent with the results reported in Jegadeesh and Titman (1993), i.e., 1.31% per month. Later, Rouwenhorst (1999) using a sample of 20 emerging markets, found that the average return from the long-short momentum strategy is 0.39% per month. Griffin et al. (2003) reported that the average monthly momentum profit from a winner-minus-loser strategy is 0.59%, 0.77%, 1.63%, and 0.32% for the U.S, Europe, Africa, and Asia, respectively. It is worthwhile to note that the higher returns observed by Jegadeesh and Titman (1993, 2001), Rouwenhorst (1999), and Griffin et al. (2003) do not necessarily imply investor profits due to higher transactions costs (Swinkels 2004; Lesmond et al. 2004). Korajczyk and Sadka (2004) found that when price impact is ignored and transaction costs are proportional costs equal to the effective and quoted spreads, the momentum strategy earns significant profits. Similarly, Lesmond et al. (2004) failed to reject profitability in all momentum strategies, even after considering transaction cost aspects. |

3 | See www.policyuncertainty.com/index.html, accessed on 20 December 2020. |

4 | See mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html, accessed on 24 December 2020. |

5 | See fred.stlouisfed.org/, accessed on 24 December 2020. |

6 | See www.nber.org/cycles/cyclesmain.html, accessed on 22 December 2020. |

7 | M3 is utilized by the central bank to direct monetary policy to control inflation. This implies that M3 has an indirect impact on inflation via monetary policy. We examined the multicollinearity among macroeconomic variables in Table 9. VIF for the regression model in Table 9 turned out to be 1.24, 1.19, and 1.16 for inflation and money supply, respectively. To further clear our suspicion towards the relationship between inflation and money supply, we checked the correlation between the two variables, which turned out to −0.1261. |

**Figure 1.**(

**a**) Co-movement between EPU and momentum portfolios. (

**b**) Co-movement between EPU and WML (hedge portfolio).

**Figure 2.**Impulse response function graphs. The figure displays the impulse response of EPU (hedge) on EPU (hedge) and hedge (EPU) across the four panels. Cholesky Ordering is utilized to obtain the results.

Variable | Obs. | Mean | Std. Dev. | Min | Max |
---|---|---|---|---|---|

HEDGE | 407 | 1.102 | 7.623 | −45.58 | 26.15 |

MKTRF | 407 | 0.663 | 4.361 | −23.24 | 12.47 |

SMB | 407 | 0.043 | 3.078 | −16.87 | 21.71 |

HML | 407 | 0.192 | 2.867 | −11.10 | 12.90 |

WML | 407 | 0.562 | 4.496 | −34.39 | 18.36 |

EPU | 407 | 108.117 | 31.34 | 57.203 | 245.127 |

Variables | (1) | (2) | (3) | (4) | (5) | (6) |
---|---|---|---|---|---|---|

(1) HEDGE | 1.000 | |||||

(2) MKTRF | −0.208 * | 1.000 | ||||

(3) SMB | 0.003 | 0.210 * | 1.000 | |||

(4) HML | −0.190 * | −0.217 * | −0.266 * | 1.000 | ||

(5) WML | 0.919 * | −0.171 * | 0.048 | −0.199 * | 1.000 | |

(6) EPU | −0.115 * | 0.075 | 0.073 | −0.103 * | −0.140 * | 1.000 |

Expansionary Period | Contractionary Period | ||
---|---|---|---|

December1982–July 1990 | 0.0149 (3.84) | August 1990–March 1991 | −0.0172 (−0.54) |

April 1991–March 2001 | 0.0034 (0.53) | April 2001–November 2001 | −0.0216 (−0.52) |

December 2001–December 2007 | 0.0032 (0.73) | January 2008–June 2009 | −0.0432 (−1.27) |

(1) Long | (2) Short | (3) Hedge | |
---|---|---|---|

MKTRF | 1.176 *** (0.0364) | 1.269 *** (0.0457) | −0.092 * (0.0509) |

SMB | 0.355 *** (0.0421) | 0.450 *** (0.0492) | −0.095 * (0.0530) |

HML | −0.121 ** (0.0521) | −0.035 (0.0847) | −0.086 (0.0824) |

WML | 0.498 *** (0.0317) | −1.036 *** (0.0476) | 1.534 *** (0.0582) |

CONS | 0.031 (0.108) | −0.290 * (0.157) | 0.322 * (0.167) |

N | 407 | 407 | 407 |

Adj. R^{2} | 0.898 | 0.880 | 0.847 |

F | 276.4 | 305.8 | 175.3 |

Mean Alpha | t-Stat | p Value | Mean Adj. R^{2} | Mean SE | Mean |a| | SR | |
---|---|---|---|---|---|---|---|

J0 | 0.322 | 4.48 | 0.034 | 0.8469 | 0.1527 | 0.3218 | 0 |

J1 | 0.321 | 4.42 | 0.035 | 0.8469 | 0.1527 | 0.3218 | 0.1084 |

(1) | (2) | (3) | |
---|---|---|---|

Long | Short | Hedge | |

MKTRF | 1.176 *** (0.0345) | 1.248 *** (0.0580) | −0.0723 (0.0616) |

SMB | 0.494 *** (0.0541) | 0.343 *** (0.0973) | 0.151 (0.0968) |

HML | −0.0287 (0.0467) | 0.222 ** (0.110) | −0.251 ** (0.118) |

WML | 0.497 *** (0.0298) | −1.104 *** (0.0767) | 1.601 *** (0.0892) |

CONS | 0.0391 (0.134) | −0.458 * (0.240) | 0.497 ** (0.246) |

N | 204 | 204 | 204 |

Adj. R^{2} | 0.910 | 0.895 | 0.867 |

F | 365.9 | 232.4 | 87.74 |

(1) Long | (2) Short | (3) Hedge | |
---|---|---|---|

MKTRF | 1.133 *** (0.0637) | 1.222 *** (0.0551) | −0.0892 (0.0769) |

SMB | 0.239 *** (0.0598) | 0.399 *** (0.0615) | −0.160 ** (0.0693) |

HML | −0.286 *** (0.106) | −0.373 *** (0.112) | 0.0872 (0.123) |

WML | 0.518 *** (0.0601) | −1.057 *** (0.0547) | 1.575 *** (0.0665) |

CONS | −0.0176 (0.157) | 0.0535 (0.173) | −0.0710 (0.194) |

N | 203 | 203 | 203 |

Adj. R^{2} | 0.896 | 0.870 | 0.826 |

F | 114.3 | 223.0 | 159.9 |

(1) | (2) | (3) | (4) | (5) | (6) | |
---|---|---|---|---|---|---|

Long | Long | Short | Short | Hedge | Hedge | |

EPU | 0.160 (0.354) | −0.0314 (0.103) | 1.037 ^{+} (0.599) | −0.150 (0.180) | −0.878 ^{+} (0.464) | 0.119 (0.186) |

MKTRF | 1.176 *** (0.0364) | 1.269 *** (0.0458) | −0.0928 ^{+} (0.0511) | |||

SMB | 0.355 *** (0.0421) | 0.453 *** (0.0488) | −0.0972 ^{+} (0.0527) | |||

HML | −0.122 * (0.0516) | −0.0413 (0.0863) | −0.0809 (0.0835) | |||

WML | 0.497 *** (0.0321) | −1.042 *** (0.0455) | 1.539 *** (0.0563) | |||

CONS | 1.083 *** (0.299) | 0.0322 (0.108) | −0.0194 (0.426) | −0.286 ^{+} (0.156) | 1.102 ** (0.376) | 0.319 ^{+} (0.165) |

N | 407 | 407 | 407 | 407 | 407 | 407 |

adj. R^{2} | −0.002 | 0.897 | 0.012 | 0.880 | 0.011 | 0.847 |

F | 0.203 | 221.3 | 3.003 | 270.2 | 3.572 | 159.9 |

^{+}, *, **, and *** denote the significance at 10%, 5%, 1%, and 0.1%.

Hedge | |
---|---|

DIV | 11.43 (8.033) |

INFLATION | 1.436 * (0.812) |

M3 | −55.07 (287.9) |

YIELD | −2.970 (2.313) |

DEFAULT | −15.56 ** (7.059) |

TERM | −4.938 ** (2.136) |

IIP | 0.461 (0.713) |

EPU | 0.0299 * (0.0171) |

CONS | 0.600 (0.711) |

N | 406 |

Adj. R^{2} | 0.091 |

F | 3.662 |

Coef. | Std. Err. | p > z | 95% Conf. | Interval | |
---|---|---|---|---|---|

Panel (A): EPU as the dependent variableEPU | |||||

L1. | 0.726 | 0.062 | 0.000 | 0.604 | 0.848 |

L2. | −0.093 | 0.078 | 0.233 | −0.245 | 0.060 |

L3. | 0.005 | 0.078 | 0.953 | −0.149 | 0.158 |

L4. | 0.273 | 0.070 | 0.000 | 0.137 | 0.410 |

HEDGE | |||||

L1. | 0.155 | 0.159 | 0.328 | −0.156 | 0.467 |

L2. | 0.421 | 0.158 | 0.008 | 0.112 | 0.730 |

L3. | −0.090 | 0.152 | 0.555 | −0.388 | 0.208 |

L4. | 0.326 | 0.140 | 0.020 | 0.051 | 0.600 |

Constant | 9.477 | 4.574 | 0.038 | 0.513 | 18.441 |

Panel (B): HEDGE as the dependent variableEPU | |||||

L1. | −0.018 | 0.022 | 0.411 | −0.060 | 0.025 |

L2. | −0.007 | 0.027 | 0.807 | −0.060 | 0.046 |

L3. | 0.016 | 0.027 | 0.548 | −0.037 | 0.070 |

L4. | −0.013 | 0.024 | 0.581 | −0.061 | 0.034 |

HEDGE | |||||

L1. | 0.088 | 0.055 | 0.112 | −0.021 | 0.196 |

L2. | −0.019 | 0.055 | 0.725 | −0.127 | 0.088 |

L3. | 0.013 | 0.053 | 0.813 | −0.091 | 0.116 |

L4. | 0.161 | 0.049 | 0.001 | 0.066 | 0.257 |

Constant | 3.837 | 1.592 | 0.016 | 0.717 | 6.956 |

Cointegrating equation: | Cointegrating Equation (1) | |

EPU (−1) | 1.000000 | |

HEDGE (−1) | 51.09338 *** | |

(5.35805) | ||

C | −162.5485 | |

Error Correction: | D(EPU) | D(HEDGE) |

Cointegrating Equation (1) | 0.018317 *** | −0.018495 *** |

(0.00508) | (0.00215) | |

D (EPU (−1)) | −0.328359 *** | −0.009266 |

(0.05121) | (0.02168) | |

D (EPU (−2)) | −0.306039 *** | −0.014115 |

(0.05164) | (0.02186) | |

D (EPU (−3)) | −0.271631 *** | 0.036195 |

(0.05208) | (0.02205) | |

D (EPU (−4)) | −0.128718 *** | 0.054237 *** |

(0.05032) | (0.02130) | |

D (HEDGE (−1)) | −0.753648 *** | −0.031366 |

(0.23890) | (0.10113) | |

D (HEDGE (−2)) | −0.374986 * | −0.056872 |

(0.20939) | (0.08864) | |

D (HEDGE (−3)) | −0.386537 ** | −0.011666 |

(0.16870) | (0.07142) | |

D (HEDGE (−4)) | −0.093585 | 0.066331 |

(0.12028) | (0.05092) | |

C | −0.035858 | −0.008797 |

(0.88857) | (0.37616) | |

Adj. R2 | 0.152158 | 0.499365 |

F | 8.976251 | 45.33162 |

Panel (A): Response of EPU | Panel (B): Response of HEDGE | ||||
---|---|---|---|---|---|

Period | EPU | HEDGE | Period | EPU | HEDGE |

1 | 17.79262 | 0.000000 | 1 | 0.187222 | 7.529812 |

2 | 12.31028 | 1.372127 | 2 | −0.489499 | 0.178284 |

3 | 8.872394 | 3.830454 | 3 | −0.444385 | −0.225921 |

4 | 6.740064 | 2.612841 | 4 | 0.599574 | 0.217503 |

5 | 7.816250 | 4.093354 | 5 | 0.728219 | 0.584200 |

6 | 10.13712 | 4.158792 | 6 | −0.614950 | −0.396321 |

7 | 10.23387 | 3.871679 | 7 | −0.496040 | −0.053057 |

8 | 9.463814 | 3.647508 | 8 | −0.186526 | −0.015110 |

9 | 9.146190 | 3.840683 | 9 | −0.029423 | 0.035556 |

10 | 9.146403 | 3.925713 | 10 | −0.140596 | −0.147335 |

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**MDPI and ACS Style**

Goel, G.; Dash, S.R.; Mata, M.N.; Caleiro, A.B.; Xavier Rita, J.; Filipe, J.A. Economic Policy Uncertainty and Stock Return Momentum. *J. Risk Financial Manag.* **2021**, *14*, 141.
https://doi.org/10.3390/jrfm14040141

**AMA Style**

Goel G, Dash SR, Mata MN, Caleiro AB, Xavier Rita J, Filipe JA. Economic Policy Uncertainty and Stock Return Momentum. *Journal of Risk and Financial Management*. 2021; 14(4):141.
https://doi.org/10.3390/jrfm14040141

**Chicago/Turabian Style**

Goel, Garima, Saumya Ranjan Dash, Mário Nuno Mata, António Bento Caleiro, João Xavier Rita, and José António Filipe. 2021. "Economic Policy Uncertainty and Stock Return Momentum" *Journal of Risk and Financial Management* 14, no. 4: 141.
https://doi.org/10.3390/jrfm14040141