Economic policy uncertainty and stock market returns: New evidence

•We investigate the predictability of Davis’s EPU index for the Chinese stock market returns.•Davis's EPU index is a better predictor of stock returns than other EPU indices.•We compare the predictability of EPU before and during three special events.•The predictability of EPU decreases rapidly with an abrupt rise in uncertainty. This paper investigates the predictive performance of the Chinese economic policy uncertainty (EPU) index constructed by Davis, Liu, and Sheng (2019) in forecasting the returns of China’s stock market. Using the univariate and bivariate predictive regression model, we confirm that the monthly EPU index can significantly and negatively impact the next month’s stock returns, and has better out-of-sample predictability than the existing EPU index and several macroeconomic variables. By comparing the forecasting effect of the EPU index before and during special events with sharply increased uncertainty, we find that the EPU’s forecasting power decline rapidly when an event of sharply increased uncertainty occurs. Finally, our conclusions are consistent through a batch of robustness tests.