Market Effects of Policy Uncertainty: A Mispricing-Based Perspective

Abstract

Clarifying the relationship between the government and the market is fundamental and critically important in modern economic and social development. Governments regulate economic activities through policy formulation and implementation. These policy adjustments directly impact asset prices and, more importantly, introduce uncertainty. The Chinese stock market, notably sensitive to policy changes, provides an ideal environment for exploring the government-market relationship. Policy uncertainty impacts stock prices through two main components: intrinsic value and mispricing deviations from intrinsic value. Existing literature primarily focuses on how policy uncertainty affects factors determining the intrinsic value of stocks, such as business operations, rather than its impact on stock mispricing. Stock mispricing is crucial for resource allocation efficiency, making it valuable to explore how policy uncertainty affects stock mispricing.

This paper empirically analyzes the impact of policy uncertainty on stock mispricing using quarterly data from A-share listed companies in Shanghai and Shenzhen from 2003 to 2020. The results indicate that rising policy uncertainty generally corrects stock mispricing, with significant asymmetry between over-valued and under-valued samples. Rising policy uncertainty reduces the mispricing of over-valued stocks while increasing the mispricing of under-valued stocks. Mechanism tests reveal that investor sentiment and market value management are the primary mechanisms through which policy uncertainty affects stock mispricing, with investor sentiment being dominant in both over-valued and under-valued samples. Heterogeneity analysis shows that policy uncertainty affects stock mispricing mainly after 2007, particularly in private and smaller firms. Internal policy uncertainty in monetary and fiscal categories increases mispricing of over-valued stocks and decreases mispricing of under-valued stocks, whereas external policy uncertainty in trade, exchange rate, and capital account categories has the opposite effect.

This paper contributes to the existing literature in three ways: first, it expands research on the market effects of policy uncertainty by examining its impact on asset prices from the perspective of stock mispricing. Second, unlike existing literature that focuses on the generation mechanism of stock mispricing from the perspectives of market investor behavior, delisting systems, information disclosure, short-selling restrictions, and financial technology, this paper systematically examines the impact of policy uncertainty on stock mispricing, enriching the research literature on factors affecting stock mispricing. Third, it reveals the intrinsic mechanisms by which policy uncertainty affects stock mispricing based on two perspectives: the passive impact of investor sentiment and the active adjustment of market value management, deepening the linkage between macroeconomic policies and micro corporate behavior.

The findings of this paper have direct policy implications: First, recognizing the importance of expectation management in financial regulation, guiding investors’ expectations of future policy changes, reducing potential policy change uncertainty, and ensuring effective policy implementation by forming stable expectations. Second, scientifically formulating the timing of policy adjustments by choosing periods when market investor sentiment is relatively high to cool down optimism and avoiding periods of low investor sentiment to reduce the negative impact of policy changes on the stock market.