Research Archives - Chicago Global

November 3, 20200

The Asset-Pricing Implications of Government Economic Policy Uncertainty

Uncertainty about the future undoubtedly impacts market participant behavior and thus could influence how assets are priced. Government policy makers not only affect the policies themselves, but also the uncertainty regarding future monetary, fiscal, and regulatory policies collectively referred to as Economic Policy Uncertainty (EPU). Because government economic policies have wide-ranging impacts on firms in all sectors, this type of uncertainty is a type of non-diversifiable (also known as systematic) risk.


In traditional financial economic theory, investors are compensated for bearing systematic market risk with higher expected returns. In other words, investors have a higher demand for assets that hedge against downturn in adverse changes to the overall market, thereby raising prices of these assets and lowering expected returns. Pástor and Veronesi (2013), both professors of finance at the Chicago Booth School of Business, suggest that economic policy uncertainty raises the equity risk premium and is a variable that affects the future investment opportunities. This implies that changes in EPU, like volatility, carries a negative price of risk. In other words, investors are willing to pay (by tolerating lower returns) on portfolios which hedge such risks.

Research Setting

To study whether such an empirical pattern exists, Brogaard and Detzel (2015) provide empirical evidence that economic policy uncertainty impacts equity returns through a time-series as well as cross-sectional analyses. Prior to this research, most extant studies relied on event studies around a particular policy change or an election; it has the advantage of being well documented with a timeline but does not provide a holistic view of EPU as a risk premium. Broggard and Detzel use a news-based measure of policy uncertainty extracted from influential news outlets (Baker et al. (2016)), a measure that allows for a continuous tracking of policy risk. This EPU index is computed by taking the weighted average of three measures of EPU which comprises a news-based measure (given the largest weight), expiring tax provisions, and forecaster disagreement about government purchases and inflation.

They found the estimated relation between economic policy uncertainty and returns for two, three, and six months in the future to be positive and statistically significant, meaning that EPU positively predicts expected excess returns and does in fact raise the equity risk premium. For quarterly returns, a one-standard deviation increase in EPU raises the expected excess quarterly returns by 6.12% annualized. These time series analyses contain a variety of time-series forecasting regressions, regressing market log excess returns (for different time periods) against EPU while controlling for variables such as monthly historical volatility, monthly implied volatility, 10-year treasury yield and several other macroeconomic variables to emphasize the incremental statistical power from EPU. The results suggest that compared to existing measures of uncertainty, EPU is different and carries additional information not contained in measures like the VIX, the forward looking 90-day volatility of the S&P 500 index which is also referred to the “fear index” and used to proxy for the general uncertainty within the market.

The paper also found that EPU affected cross-sectional returns of stocks, even when accounting for standard Fama-French and liquidity exposures. Portfolios positively correlated with EPU rise in value with EPU rises. Therefore, investors will be willing to pay a higher price (and tolerate lower returns) for portfolios that are more positively correlated with EPU. The paper shows that within the Fama-French 25 independently sorted size and momentum, shorting the portfolio with the highest exposure to EPU and going long the one with the lowest exposure to EPU delivers an average of 5.53% annual alpha relative to standard risk factors.

What does that mean for investors?

Following periods of higher economic policy uncertainty, equity market returns tend to generate higher returns. Investors who can tolerate such risks will tend to be rewarded for staying in the market during periods of heightened economic policy risks. In addition, portfolios that serve to hedge these risks tend to have lower returns. Although not every risk is compensated for with more average returns, economic policy uncertainty appears to be a relevant priced risk factor.

Investors should be mindful of the levels of economic policy uncertainty risks they are willing to tolerate. Portfolios that tend to lose value with EPU rises tend to have higher average returns on average for bearing the EPU risk. However, an optimal investment portfolio should be tailored to the risk tolerance of the investors rather than simply aiming to maximize returns at any costs. One way to manage EPU risk is to blend the portfolio exposure to other imperfectly correlated sources of returns, allowing diversification across return drivers to reduce the overall portfolio risk to help investors remain patient and disciplined even during times when economic policy uncertainty is high.

To see how the Chicago Global’s portfolio performs during periods of higher economic policy uncertainty and how the EPU risk exposures compares with the global market benchmark, login to read our research note.


Baker, Scott R, Nicholas Bloom, and Steven J Davis. 2016. “Measuring Economic Policy Uncertainty.” The Quarterly Journal of Economics 131 (4): 1593–1636. doi:10.1093/qje/qjw024.Advance.

Brogaard, Jonathan, and Andrew Detzel. 2015. “Policy Uncertainty The Asset-Pricing Implications of Government Economic Policy Uncertainty.” Management Science 61 (1): 3–18.

Pástor, Luboš, and Pietro Veronesi. 2013. “Political Uncertainty and Risk Premia.” Journal of Financial Economics 110 (3): 520–45. doi:10.1016/j.jfineco.2013.08.007.


January 30, 20200

From a research summary in the June 2019 issue of the NBER Digest (PDF embedded below) written by Steve Maas at the National Bureau of Economic Research. Our annotations are in bold.

Drawing on newspaper stories about stock market volatility, Scott R. BakerNicholas BloomSteven J. Davis (the William H Abbot Professor of International Business and Economics at the University of Chicago Booth School of Business), and Kyle J. Kost examine the importance of various types of news in contributing to swings in equity prices.

The researchers create an Equity Market Volatility (EMV) tracker that links articles about economic, political, and national security developments to the VIX index, a measure of expected stock market volatility based on option prices. In Policy News and Stock Market Volatility (NBER Working Paper No. 25720 – PDF Embedded below), they report that movements in their EMV tracker closely mirror the ups and downs in the realized and option-implied volatility of the S&P 500 between January 1985 and October 2018.

The EMV tracker is constructed by searching articles published in 11 major U.S. newspapers, including The New York Times, the Los Angeles TimesThe Dallas Morning News, and The Wall Street Journal.

The researchers classified the EMV articles into about 30 categories of factors that influence volatility. These included 10 related to general economic factors, such as macroeconomic news, labor disputes, and financial crises. The rest related to political or policy factors such as taxes, government spending, and monetary policy. Each category is associated with a set of search terms. In most cases, journalists who authored the articles tied instability to factors in multiple categories.

News about the macroeconomic outlook appears in 72 percent of the articles that enter into the EMV tracker. This category covers reports about GDP, inflation, housing starts, jobs, and other indicators of the broad economic outlook. That compares with 44 percent of EMV articles in the “commodity market” category, citing terms such as wheat, steel, and oil pipeline. Journalists attributed volatility to news about interest rates in 31 percent of the articles; national security matters were cited in just 13 percent of the articles.

The share of news stories about market volatility that fell into each category fluctuated over time. For example, the period since the 2016 election has seen a sharp increase in trade policy concerns as an apparent source of market volatility.

The researchers created not just an overall EMV tracker, but several category-based versions as well. The EMV tracker for macroeconomic news jumped in response to the October 1987 market crash, the Russian financial crisis, and the 2008–09 global financial crisis. In contrast, it registered little reaction to the Enron and WorldCom scandals. The “financial crisis” EMV tracker has registered consistently higher volatility in the years since the 2008-09 meltdown, but it also reacted strongly to earlier crises such as those involving the Mexican peso in 1994 and the Russian and Asian financial crises in 1997-98. An EMV tracker for petroleum markets, using such search terms as oil, Alaska pipeline, and Keystone pipeline, mirrors most movements in oil-price volatility but missed badly during times of economic crisis like the 1987 stock market crash and the 2008-09 global financial crisis.

News about policy matters is an important and growing contributor to volatility. The researchers find that 35 percent of EMV articles refer to fiscal policy, mostly taxes, 30 percent discuss monetary policy, 25 percent refer to one or more forms of regulation, and 13 percent mention national security. They find “an upward drift over time” in the share of articles about market volatility that discuss policy matters, with a peak contribution of policy matters in 2017-18.


January 30, 20200

From a research summary in the June 2019 issue of the NBER Digest (see embedded PDF below) written by Linda Gorman at the National Bureau of Economic Research. Our annotations are in bold.

Investors increase the share of equities in their portfolios by about 0.7 percentage points when the return that they expect to earn on stocks rises by 1 percentage point.

Textbooks in economics and finance often caution investors against trying to “time the market,” but survey evidence suggests that there is substantial variation over time in the return investors expect to earn by holding corporate stocks. How does such variation in expected returns translate into portfolio choices? In Five Facts about Beliefs and Portfolios (NBER Working Paper No. 25744 – PDF embedded below), Stefano Giglio (formerly at the University of Chicago Booth School of Business)Matteo MaggioriJohannes Stroebel, and Stephen Utkus use an online survey of Vanguard customers’ beliefs about future stock returns, GDP growth, and bond returns to compare investors’ expectations with their subsequent behavior.

Randomly chosen Vanguard customers participated in online survey waves from February 2017 through August 2018. There were about 2,000 survey responses per wave. If a customer responded in a wave, he was contacted again in subsequent waves. About 35 percent of the responses came from investors who responded to only one survey. Over 25 percent of respondents participated in at least four survey waves.

Compared to a nationally representative set of investors, survey participants tended to be older — the average age was 58.7 — and richer. Respondents had an average of $467,000 invested with Vanguard. The average expected one-year market return among survey participants was 5.23 percent.

The survey data show that there is a positive relationship between an investor’s expectation of the return in the next year on a stock portfolio and that investor’s portfolio composition, but that the share of the portfolio allocated to equities is relatively less sensitive to changes in expected return compared with predictions from frictionless benchmark macrofinance models. On average, an investor expecting a 1 percentage point increase in returns over the next year increases portfolio equity holdings by about 0.7 percentage points.

While this sensitivity of portfolios to beliefs is lower than in frictionless models, there is substantial heterogeneity in that sensitivity across investors lines up with different frictions investors face. Portfolios in tax-advantaged accounts were more sensitive to changes in investors’ expectations than portfolios subject to capital gains taxes, especially if holdings were above $100,000. Portfolios in institutionally managed defined-contribution plans were about half as sensitive to changes in expectations as portfolios in individually managed plans. Investors who paid more attention to their accounts, investors who traded more frequently, and investors who were more confident in their beliefs, all had portfolios that were more strongly aligned with their expected stock returns.

There are large persistent differences across individuals in the expected stock returns. Individual fixed effects account for more than half of the variation in expectations: beliefs of optimists and pessimists are both far apart and persistent. These expectations are not well predicted by observable characteristics such as gender, age, wealth, or geographic location.

The survey asked about expectations that range beyond stock returns, and individual expectations tend to be correlated across responses. Beliefs about GDP growth and short- and long-run stock expectations are positively correlated. Those who think a stock market disaster is more likely also expect lower future cash flows and lower future returns. The empirical results imply that investors disagree about the very-long-term evolution of the market price, and that this disagreement plays an important role in determining investor beliefs. They also suggest that survey data can reveal beliefs relevant for actual investor behavior, and therefore emphasize the potential for survey data to inform macro finance theories.


January 30, 20200

Ben Charoenwong & Alan Kwan

As Asian economies grow and wealth accumulates, more households turn towards experts for investment advice. There is no denying that the financial services sector in Asia has exploded. A recent industry report by Ernst and Young estimates that the wealth of high net-worth individuals alone in Asia is over USD$9 trillion as of 2016. But despite this astronomical growth in the asset management industry, the regulatory framework in Asia is still developing.

The main responsibility of an investment adviser is to provide clients advice on financial planning and asset allocation but may also help to implement such recommendations. To protect investors who might be less sophisticated, the United States and many other countries uphold advisers to fiduciary duty standards. In our research, we show that not only the fiduciary standard is important, but the quality of local regulators in the United States makes a large difference in misconduct. This highlights the importance of the fiduciary standard, but also the importance of having an international standard so that both advisers and clients can operate in comparable settings. Yet, the fiduciary duty is not a standard requirement between financial advisers and clients for most countries in Asia.

The consequence of this regulatory gap reveals itself intermittently on the front pages of financial news. Just recently in December of 2017, a large online investment scheme in China was found out to be a fraud. Founded in 2012, promised returns of up to 60 percent a year and raised over USD$4.7 billion. When found out to be a Ponzi scheme, protests broke out in the Jiangsu province of Nanjing. But prior to the founder turning himself in, the official state news Xinhua news simply warned the company, “Don’t organize and don’t participate in illegal activities”. Worse yet, this scandal came on the heels of a $7.7 billion financial scam in online lender Ezubo in 2015.

The absence of a coherent regulatory and enforcement framework means that authorities do not have a systematic approach to dealing or monitoring misconduct in the investment advisory industry. As this industry grows, the role of regulators become more important in ensuring a fair environment for investors. To this end, regulators in Asia is considering whether to impose and enforce a fiduciary duty on investment advisers.

Whether financial advisers have a fiduciary duty determines the legal liability of their actions.  A fiduciary duty is an ethical and legal relationship of trust between two people. If a person violates their fiduciary duty, they are personally liable to account for the ill-gotten profits. They may face both civil or criminal legal consequences.

Compared to the regulatory environment in the United States, established by the Investment Adviser Act in 1940, the regulatory framework in Asia for financial advisers is both young and lax. For example, according to the Investment Adviser Act of 1940 in the United States, all investment advisers are fiduciaries. Investment advisers shown to commit fraud or knowingly sell unnecessarily expensive financial products may face fines, lose their advising license, or even face jail time.

Out of the 9 countries for which we could find data, only three dictates a fiduciary relationship between advisers and clients. This is in stark contrast to the fiduciary relationship required of all board of directors and shareholders for all 9 countries.

Asian countries also differ in the stringency of the investment adviser regulatory landscape. In Singapore, financial advisers are required to show their compensation scheme in writing, be it fee-based or commissions-based or both. On the other hand, in Hong Kong, financial advisers do not even need to disclose their commission rebates, remuneration, or soft dollar benefits which they receive from product providers.


Country Investment Adviser Industry Size
(billions USD)
Fiduciary Duty Regulator Governing Law Year Enacted[1]
China 28,000 No China Securities Regulatory Commission Securities Investment Fund Law of the People’s Republic of China 2012
Hong Kong 23,000 No Securities and Futures Commission Securities and Futures Ordinance 2002
Singapore 2,000 No Monetary Authority of Singapore Financial Advisers Act 2001
South Korea 434 Yes Financial Services Commission Financial Investment Services and Capital Markets Act 2007
Taiwan 163 Yes Financial Supervisory Commission Republic of China (Taiwan) Financial Consumer Protection Act 2011
Malaysia 151 No Securities Commission Malaysia Securities Commission Act 1993
Thailand 121 No Thailand Securities and Exchange Commission Securities and Exchange Act 1992
Philippines 54 Yes Bangko Sentral ng Pilipinas Monetary Board Resolution No. 26 2011
Indonesia 20 No Financial Services Authority Capital Markets Law No. 8 of 1995. 2011


Although the absence of an explicit fiduciary duty relationship between investment advisors and clients do not mean that clients are not protected, the requirements are less stringent. For example, in Singapore, the Financial Advisers Act does not impose a fiduciary duty on financial advisers. It only requires that investment advice be made on a “reasonable basis”. This means that legally, financial advisers only have the duty to represent their firm’s interests, not necessarily that of clients. Investors seeking investment advice from these advisers should be wary of how the advisers are compensated and their incentives for giving a certain type of advice.

Identifying a licensed financial adviser may also be difficult. In some countries, they are not required to disclose their registration status. The burden lies with investors to find out. For example, Singapore reserves the term “financial adviser” only for individuals who are registered and regulated under the Financial Advisers Act. However, the use of the terms “financial planner”, “financial analyst”, or “financial consultants” are not reserved and can be used by anyone.

Given the inherent conflict of interests in the financial adviser industry, since there seems to be a regulatory gap in Asia, the burden falls upon investors to understand the investment management industry. Unsurprisingly, most investors prefer to use simpler assets as store of wealth, such as bank deposits, certificates of deposit, or even real estate.

[1] This refers to the original enactment, ignoring revisions. Typically, revisions are implemented to make the regulation more stringent. The fiduciary duty requirement column reflects the current regulatory framework .


January 30, 20200

Ben Charoenwong & Alan Kwan

Many people rely on financial advisers when making important financial decisions. The United States 2013 Survey of Consumer Finances finds 58% of American households are a client of some investment adviser, who collectively manage over $66 trillion in assets as of 2015.This is over four times the total assets of all commercial banks. As of December 31, 2015, the total assets of all commercial banks according to the Federal Reserve Board of Governors was $15.5 trillion.

The fiduciary duty is an ethical and legal relationship of trust between two parties. It consists of the duty of care, duty of loyalty, duty of good faith, duty of confidentiality, duty of prudence, and duty of disclosure. As the highest standard of legal care, if a person violates their fiduciary duty, they are personally liable for all ill-gotten profits or any losses. However, a fiduciary duty does not imply that the person must place their clients’ interests before their own. The fiduciary duty is subject to interpretation and may vary in execution and enforcement quality.  More surprising is the apparent failure of the market to remove bad actors: 50% of advisers lose their jobs after misconduct and 44% of terminated advisers find work within the industry in one year.

The high re-employment rates for misbehaving advisers motivates examining the importance of regulators in curbing misconduct. In our forthcoming paper in the American Economic Review, with Tarik Umar, an assistant professor at Rice University, we study whether regulator jurisdiction affects misconduct in the financial adviser industry.

In our paper, we exploit a rare opportunity to study a change in regulatory jurisdiction. The Dodd-Frank Wall Street Reform and Consumer Protection Act mandated that the SEC transfer oversight of “mid-sized” advisers – those with between $25 to $100 million in assets under management – from the Securities and Exchange Commission (SEC) to state regulators. This change was announced on July 21, 2011, and in effect by January 1, 2012. We explore whether advisers who switched from the SEC to state regulator received more complaints, and whether this increase in complaints reflects weakened regulatory oversight.

Regulators may be important in monitoring advisers directly, educating investors, implementing regulation, and identifying and investigating a specific act of misconduct. Oversight of investment advisers is currently divided between a national regulator (the SEC) and state regulators, with the SEC overseeing larger and more complex advisers. A national regulator may have superior human capital, organizational practices, and visibility. In contrast, a state regulator may have better soft information and be more accessible to local constituents.