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Publisher : Elsevier - Science Direct (الزویر - ساینس دایرکت)
Journal : Journal of Banking & Finance, Volume 32, Issue 9, September 2008, Pages 1941–1953
This paper investigates a sample of 27 OECD countries to test whether national elections induce higher stock market volatility. It is found that the country-specific component of index return variance can easily double during the week around an election, which shows that investors are surprised by the election outcome. Several factors, such as a narrow margin of victory, lack of compulsory voting laws, change in the political orientation of the government, or the failure to form a government with parliamentary majority significantly contribute to the magnitude of the election shock. Furthermore, some evidence is found that markets with short trading history exhibit stronger reaction. Our findings have important implications for the optimal strategies of institutional and individual investors who have direct or indirect exposure to volatility risk.
In his seminal paper Shiller (1981) argues that the observed stock market volatility is inconsistent with the predictions of present value models. The intertemporal variation appears to be inexplicably high and cannot be rationalized even in a model with a stochastic discount factor (Grossman and Shiller, 1981). Although several authors (Flavin, 1983 and Kleidon, 1986) questioned the conclusion of excessive volatility on methodological grounds, latter tests accounting for dividend nonstationarity and small sample bias continued to lend support to Shiller’s initial claim (see Mankiw et al., 1985, Mankiw et al., 1991, West, 1988, Zhong et al., 2003 and Coakley and Fuertes, 2006). The failure of standard valuation models to explain the magnitude of stock market fluctuations poses a serious challenge to financial economists. Drivers of volatility other than the conventional dividends and earnings need to be identified and evaluated. Schwert (1989) examines empirically whether the aggregate stock return variability can be linked to macroeconomic variables, financial leverage, and trading volume. His in-depth analysis indicates that only a small proportion of the fluctuations in the market volatility can be explained. The inquiry undertaken in our paper takes a different route and proceeds to show that stock markets can become very unsettled during the periods of important political changes. In particular, we provide evidence that stock market volatility is substantially raised around national elections. Since elections are essentially rare events, our analysis rests on a multi-country approach and the data set constructed for this study covers 27 industrialized nations. The investigation into return volatility around elections is warranted on at least three grounds. First, the uncertainty about the election outcome has important implications for risk-averse investors. Prior research has shown that investors are undiversified internationally and exhibit a significant home bias (French and Poterba, 1991 and Baxter and Jermann, 1997). Since they hold predominantly domestic assets, the country-specific political risk will not diffuse in their portfolios. Consequently, the sole event of elections in their home country could have implications for the risk level of their portfolios. Second, any market-wide fluctuations in response to election shocks will augment the systematic volatility of all stocks listed. It is therefore conceivable that option prices could increase around the time when voters cast their ballots. Finally, the results reported here can be of interest to pollsters as they provide indirect evidence on whether the accuracy of pre-election forecasts suffices for practical applications. An observation of volatility hikes around an Election Day would indicate that the efforts to formulate precise predictions should be furthered and additional resources need to be directed towards this end.
نتیجه گیری انگلیسی
This study investigates the interplay between politics and finance by focusing on stock market volatility around national elections. The value added of this paper is twofold. First, it provides a detailed examination of the second moment of index return distribution around election dates. Since much of the uncertainty regarding future government policies is resolved during balloting periods, the stock prices can adjust dramatically and stock market volatility is likely to increase. To the best of the authors’ knowledge, it is the first study that rigorously quantifies the magnitude of this increase. Second, we stretch the limits of earlier research by overcoming the commonly used single-country approach and by introducing a new, extensive set of explanatory variables. The impact of elections on country-specific stock market volatility is assessed in an event-study framework. Our empirical findings indicate that, despite many efforts to accurately predict election outcomes, investors are still surprised by the ultimate distribution of votes. Stock prices react strongly in response to this surprise, and temporarily elevated levels of volatility are observed. We find that the country-specific component of volatility can easily double during the week surrounding elections. In the light of the presented results, it becomes clear that the efforts to provide more accurate pre-election forecasts should still be furthered. Improvements in forecasting precision will help to bridge the gap between actual investors’ requirements and the current state of the art. To track down the main determinants of electioninduced volatility, we have compiled an encompassing data set of political, institutional, and socio-economic variables. Five of the variables proved to influence the magnitude of election surprise in a significant way. Stock market participants tend to react in a more volatile manner during closely contested races, when the outcome of the election brings about a change in the political orientation of the government, and when governments do not secure parliamentary majorities. In all of these cases, investors perceive increased uncertainty. On the other hand, compulsory voting laws reduce the election shock. Enactment of such laws leads to higher voter turnout, which improves the accuracy of pre-election surveys and reduces the chances that the election outcome will be influenced by political fringe groups. Lastly, markets with shorter history of trading tend to exhibit stronger abnormal reaction. The implications for investors are tangible and important. Risk-averse agents require an adequate premium whenever they need to take on additional risks. It turns out, however, that the compensation for bearing electioninduced risk is rather modest and would be acceptable only for investors with a relatively low degree of risk aversion. All other investors will attain higher expected utility by diversifying their portfolio internationally. We also show that national elections are important events for the participants of the options markets, as in the heat of political changes options tend to trade at higher implied volatilities. Directional traders can cash in on the volatility jump by designing certain option trading strategies or by taking positions in variance swaps and volatility futures. Furthermore, some financial institutions, such as banks and hedge funds, should be vigilant during the election period as their profits or capital requirements are a function of the underlying volatility.