The Impact Of Economic Policy Uncertainty On Financial Markets

The risk of economic policy uncertainty is increasing,with Chinese economy is slowing down.The financial system in China is still underdeveloped which constrains the capacity of the financial markets to provide enough safe assets.In addition,China has strict control over financial account.As a result,economy has limited choices of assets that can be used to store value,and there is scarcity of safe assets.In this context,it is important to analyze the impact of economic policy uncertainty on China's financial market.This research can help us to better understand China's economic policy uncertainty and the scarcity of safe assets.Firstly,we construct a simple two-period partial equilibrium model to convey that higher economic policy uncertainty brings about the increasing demand for these relatively better quality assets.In the empirical part,we choose four markets of stock,bond,real estate and foreign exchange as the research object.we construct VAR model for different assets,and then we apply a new identification method named max-share to identify the economic policy uncertainty shock.We use IRF to analyze the impact of policy uncertainty on different assets and markets.The empirical result is that the economic policy uncertainty shock will lead to the decline of stock returns and trading volume,the return on RMB will decline and the capital outflow to foreign exchange,the credit spread of high-rating corporate bonds will be significantly narrowed,and the price of the housing assets will increase rapidly especially those of better quality.Higher-quality bonds,housing assets assumes the role of relatively safe asset,the price of safe assets is booming when faced with higher policy uncertainty,which supports our hypothesis.China's real estate market has absorbed a huge amount of wealth,and the real estate bubble is growing,which has a crowding out effect on the real economy.This paper believes that China's bond market is underdeveloped and has great room to develop.Quality bonds can be fully used to smooth consumption and play the role of store of value when economy policy uncertainty increase,which will improve the stability of China's financial system.