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Politics and Volatility

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Author Info
Boutchkov, Maria
Doshi, Hitesh
Durnev, Art
Molchanov, Alexander

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Abstract

We investigate how politics (party orientation, national elections, and strength of democratic institutions) affect stock market volatility. We hypothesize that labor-intensive industries, industries with larger exposure to foreign trade, industries whose operations require efficient contracts, and industries susceptible to government expropriation are more sensitive to changes in political environment. Using a large panel of industry-country-year observations, we show that politically-sensitive industries exhibit higher volatilities during national elections. Volatility is also higher for labor-intensive industries under leftist governments. Moreover, governance-sensitive industries and industries under a higher risk of expropriation are more volatile when democratic institutions are weak. The rise in volatility is driven largely by systematic risk rather than firm-specific risk. The results are consistent with the 'peso problem' hypothesis that uncertainty about future government policies can increase stock market volatility.

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Publisher Info
Paper provided by Center for Economic Institutions, Institute of Economic Research, Hitotsubashi University in its series CEI Working Paper Series with number 2008-10.

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Length: 46 p.
Date of creation: Apr 2008
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Handle: RePEc:hit:hitcei:2008-10

Note: November 14, 2007, Preliminary and incomplete
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