Markets under Siege: How Differences in Political Beliefs Can Move Financial Markets

Can differences in beliefs about politics, particularly the benefits of war and peace, move markets? During the Siege of Paris by the Prussian army (1870-71) and its aftermath, we document that the price of the French 3% sovereign bond (rente) differed persistently between the Bourse in Paris and elsewhere, despite being one of the most widely held and actively traded financial assets in continental Europe. Further, these differences were large, reaching the equivalent of almost 1% of French GDP in overall value. We show these differences manifested themselves during the period of limited arbitrage induced by the Siege and persisted until the terms of peace were revealed. As long as French military resistance continued, the rente price was higher in Paris than the outside markets, but when the parties ceased fire and started negotiating peace terms this pattern was reversed. Further, while the price responded more to war events in Paris, the price responded more to peace events elsewhere. These specific patterns are difficult to reconcile with other potential mechanisms, including differential information sets, need for liquidity, or relative market thickness. Instead, we argue, these results are consistent with prices reflecting the updating of different prevailing political beliefs that existed in Paris and elsewhere about the benefits of war and peace.