Economic Policy Uncertainty and Stock Markets Co-movements

We empirically examine co-movements between the Economic Policy Uncertainty (EPU) index and selected stock market indices (S&P500, UK100, Nikkei225, and DAX30) at different investment horizons. We show significant but time-variant co-movements between EPU and stock markets employing wavelet analysis. Moreover, we identify EPU as a leading indicator of stock market drops, especially in the US, Japan, and Germany by using the time-varying domain based on the wavelet coherence. The lag between the changes of EPU and selected stock markets is from 4 months up to 32 months for longer investment horizons. We identify the co-movements between the EPU and stock markets also in times of decreased uncertainty but only to a small extent.