This paper presents a general equilibrium model of government policy choice in which stock prices respond to political news. The model implies that political uncertainty commands a risk premium whose magnitude is larger in weaker economic conditions. Political uncertainty reduces the value of the implicit put protection that the government provides to the market. It also makes stocks more volatile and more correlated, especially when the economy is weak. The authors find empirical evidence consistent with these predictions. The model shows that stock prices are driven by three types of shocks: capital shocks, impact shocks, and political shocks. Capital shocks are related to changes in aggregate capital, while impact shocks are related to changes in the government's policy impact on profitability. Political shocks are related to learning about the political costs of potential new policies. The authors decompose the equity risk premium into three components corresponding to these shocks. Political shocks command a risk premium despite being unrelated to economic shocks. Investors demand compensation for uncertainty about the outcomes of purely political events, such as debates and negotiations. These events matter to investors because they affect their beliefs about which policy the government might adopt in the future. The composition of the equity risk premium is highly state-dependent. The political risk premium is larger in weaker economic conditions. In a weaker economy, the government is more likely to adopt a new policy, so news about which new policy is likely to be adopted—political shocks—have a larger impact on stock prices. The political risk premium is also larger when political signals are more precise. In strong economic conditions, the political risk premium is small, but the impact-shock component of the equity premium is large. When times are good, the current policy is likely to be retained, so news about the current policy’s impact—impact shocks—have a large effect on stock prices. Impact shocks matter less when times are bad because the current policy is then likely to be replaced, so its impact is temporary. The equity premium in weak economic conditions is affected by two opposing forces. On the one hand, the premium is pulled down by the government’s implicit put protection, which results from the government’s tendency to change its policy in a weak economy. This protection reduces the equity premium by making the effect of impact shocks temporary and thereby depressing the premium’s impact-shock component. On the other hand, the premium is pushed up by political uncertainty, as explained earlier. Political uncertainty thus reduces the value of the put protection that the government provides to the market. Political uncertainty pushes up not only the equity risk premium but also the volatilities and correlations of stock returns. As a result, stocks tend to be more volatile and more correlated when the economy is weak. The volatilities and correlations are also higher when the potential new government policies are perceived as more heterogeneous a priori. The government’s ability to change its policy has an ambiguous effect on stock prices. The authors find that the ability to change policy makes stocks more volatile and more correlated in poor economic conditions. Interestingly, this ability can imply aThis paper presents a general equilibrium model of government policy choice in which stock prices respond to political news. The model implies that political uncertainty commands a risk premium whose magnitude is larger in weaker economic conditions. Political uncertainty reduces the value of the implicit put protection that the government provides to the market. It also makes stocks more volatile and more correlated, especially when the economy is weak. The authors find empirical evidence consistent with these predictions. The model shows that stock prices are driven by three types of shocks: capital shocks, impact shocks, and political shocks. Capital shocks are related to changes in aggregate capital, while impact shocks are related to changes in the government's policy impact on profitability. Political shocks are related to learning about the political costs of potential new policies. The authors decompose the equity risk premium into three components corresponding to these shocks. Political shocks command a risk premium despite being unrelated to economic shocks. Investors demand compensation for uncertainty about the outcomes of purely political events, such as debates and negotiations. These events matter to investors because they affect their beliefs about which policy the government might adopt in the future. The composition of the equity risk premium is highly state-dependent. The political risk premium is larger in weaker economic conditions. In a weaker economy, the government is more likely to adopt a new policy, so news about which new policy is likely to be adopted—political shocks—have a larger impact on stock prices. The political risk premium is also larger when political signals are more precise. In strong economic conditions, the political risk premium is small, but the impact-shock component of the equity premium is large. When times are good, the current policy is likely to be retained, so news about the current policy’s impact—impact shocks—have a large effect on stock prices. Impact shocks matter less when times are bad because the current policy is then likely to be replaced, so its impact is temporary. The equity premium in weak economic conditions is affected by two opposing forces. On the one hand, the premium is pulled down by the government’s implicit put protection, which results from the government’s tendency to change its policy in a weak economy. This protection reduces the equity premium by making the effect of impact shocks temporary and thereby depressing the premium’s impact-shock component. On the other hand, the premium is pushed up by political uncertainty, as explained earlier. Political uncertainty thus reduces the value of the put protection that the government provides to the market. Political uncertainty pushes up not only the equity risk premium but also the volatilities and correlations of stock returns. As a result, stocks tend to be more volatile and more correlated when the economy is weak. The volatilities and correlations are also higher when the potential new government policies are perceived as more heterogeneous a priori. The government’s ability to change its policy has an ambiguous effect on stock prices. The authors find that the ability to change policy makes stocks more volatile and more correlated in poor economic conditions. Interestingly, this ability can imply a