Democratic Processes and Financial Markets

Abstract

The authors examine the conditions under which democratic events, including elections, cabinet formations, and government dissolutions, affect asset markets. Where these events have less predictable outcomes, market returns are depressed and volatility increases. In contrast, where market actors can forecast the result, returns do not exhibit any unusual behavior. Further, political expectations condition how markets respond to the political process. When news causes market actors to update their political beliefs, market actors reallocate their portfolios, and overall market behavior changes. To measure political information, Professors Bernhard and Leblang employ sophisticated models of the political process. They draw on a variety of models of market behavior, including the efficient markets hypothesis, capital asset pricing model, and arbitrage pricing theory, to trace the impact of political events on currency, stock, and bond markets. The analysis will appeal to academics, graduate students, and advanced undergraduates across political science, economics, and finance.

Modeling Macro-Political Dynamics

“…41 This is consistent with recent results in international political economy such as Bernhard and Leblang (2006). Second, presidential approval is expected to have a contemporaneous effect on interest rates and on the reaction of the Federal Reserve (Beck 1987, Williams 1990, Morris 2000.…”

US Political Shocks, Global Banks, and International Financial Markets: Evidence from the 2016 Presidential Election

“…Elections are among the main types of political events to elicit market reactions. As democratic turnover has the potential to affect returns to capital through shifts in the orientation of economic and regulatory policy, investors pay close attention to elections, trying to assess the probabilities of future policies and to form expectations of future returns (Sattler, 2013;Bechtel, 2009;Bernhard and Leblang, 2006). Political events in the United States, in particular, have the potential to affect investor behavior on a global scale.…”

“…While it has been extensively shown that national elections affect outcomes in financial markets, existing work has largely focused on their impact on domestic markets (e.g. Bechtel, 2009;Sattler, 2013;Bernhard and Leblang, 2006;Leblang and Mukherjee, 2005; though see Bernhard and Leblang, 2006, Ch. 4).…”

The political economy of the euro area's sovereign debt crisis: introduction to the special issue of theReview of International Political Economy

“…Why did market sentiments change rather abruptly in late 2009 and early 2010? Some scholars working on the political economy of currency crises and debt crises argue that that in order to understand the divergence between a country's economic fundamentals and the pricing of its currency or sovereign debt, it is necessary to take into account political as well as economic factors during crises periods (Bernhard and Leblang 2006;Leblang and Satyanath 2006). Building on and contributing to this literature, Chang and Leblond (2015) argue that macroeconomic indicators, such as the levels of debt and deficit provide only a partial explanation for differences in bond yields.…”