Policy uncertainty beyond market volatility: Evidence from the cross-section of U.S. stock returns

This paper examines whether policy uncertainty contains asset-pricing information beyond standard risk factors and market-wide volatility. We construct a Portfolio Mimicking Policy factor, denoted PMP, from the residual component of U.S. Economic Policy Uncertainty after removing its contemporaneous movement with the VIX. PMP is formed by sorting S&P 500 stocks according to their sensitivity to residual policy uncertainty and taking the return spread between high- and low-sensitivity portfolios. Using monthly data from 2010 to 2025, we test whether PMP improves the pricing of the 25 Fama–French size and book-to-market portfolios. The results show that standard models leave significant pricing errors, while adding PMP substantially reduces these errors. The GRS test no longer rejects the joint zero-alpha restriction once PMP is included. Regime-based tests show that PMP remains relevant in both high- and low-uncertainty periods, with stronger pricing visibility during low-uncertainty regimes. Overall, the evidence suggests that policy-specific uncertainty is not fully captured by conventional equity factors or market-implied volatility.