Elections, Cross-Border Disagreement, and Volatility

Abstract:     
Using surveys of foreign exchange expectations, we document the emergence of a large gap between the beliefs of foreign banks and local-based institutions ahead of Brazil's 2002 presidential elections. That period was marked by a sudden stop in foreign capital flows and steep depreciation of Brazilian financial assets. While foreigners have their beliefs "marked to the market", locals forecasted a strong market rebound. The belief gap closed soon after the elections, as the president-elect reaffirmed the continuity of macroeconomic policy and markets rebounded, as locals had predicted. Trading data in Brazilian stock exchange are consistent with survey evidence. Our analysis supports the view that emerging market financial crises may be precipitated by non-structural reasons such as information frictions affecting foreign investors.

Number of Pages in PDF File: 21

Keywords: sudden stop, elections, cross-border disagreement, currency crises

JEL Classification: F31, F32, F34, G14, G15

working papers series