Political uncertainty and bond defaults: evidence from the Chinese market

In this paper, we provide new evidence on how political uncertainty influences bond default, using China’s local officials’ turnover as a source of plausibly exogenous variation in uncertainty. We find that officials’ turnover increases bond defaults when political links are stronger, indicating that political turnover can destabilize government support for politically connected bonds. Additionally, off-budget resources have expanded China’s local government’s ability to bail out local bonds. Further results show that political connections create zombie bonds that ought to be out but instead to be in the market, reducing the allocative efficiency of financial resources. Our study suggests that, at least in some countries, political uncertainty influences financial risk through the mechanism of political connection.