Economic Policy Uncertainty and the Cross-Section of Corporate Bond Returns

Abstract

This article finds that economic policy uncertainty (EPU) is a systematic risk factor priced in the cross-section of corporate bonds. Bonds with high EPU beta have low expected returns, and this negative premium is robust to controlling for conventional risk factors, bond characteristics, and macroeconomic conditions and uncertainty. The effect of policy risk is pervasive, stronger for speculative-grade bonds, and priced in both US and foreign markets. The EPU risk effect is greater for firms that have higher earnings exposure to policy uncertainty, dependence on external financing, and effective tax rates; those with lower pre-tax interest coverage; and those that operate in regulation-intensive industries.