Non-linear Dynamics of Economic Policy Uncertainty and Bank Stock Returns in India

Abstract

The article investigates the dynamics of economic policy uncertainty and bank stock returns in India, a major emerging market economy. The analysis distinguishes between domestic and global sources of policy uncertainty and employs a non-linear Markov regime-switching model to capture regime-dependent behaviour in bank stock performance. Using monthly data from July 2003 to April 2023, a period spanning nearly two decades and encompassing several major domestic and global shocks, the study provides robust evidence that global economic policy uncertainty does not exert a statistically significant influence on Indian bank stock returns. In contrast, domestic economic policy uncertainty exhibits heterogeneous, state-dependent effects, indicating that its impact varies across low- and high-volatility regimes. The findings contribute to a deeper understanding of risk transmission in financial markets, offer valuable insights for risk management and policy design, and enhance comprehension of the complex interlinkages between economic policy, financial markets, the banking sector and the broader macroeconomic environment. JEL Codes: G12, G18, G21