When Investors Enjoy Less Policy Risk: Divided Government, Economic Policy Change, and Stock Market Volatility in Germany, 1970-2005
Swiss Political Science Review, Vol. 14, No. 2, pp. 287-314
28 Pages Posted: 16 Mar 2008 Last revised: 29 May 2013
Abstract
How does divided government affect the probability of economic policy change, and thus policy risk on financial markets? In contrast to the standard balancing model we argue that divided government, i.e., partisan conflict between the executive and the legislative branches, negatively affects the possibility of economic policy change. Using a simple spatial model we demonstrate that one should expect divided government to increase the probability of policy gridlock. Since divided government reduces the probability of economic policy change, financial markets can operate under lower policy risk in times of divided than in periods of unified government. For the empirical evaluation we exploit the fact that stock return volatility provides us with a measure of risk. If the gridlock argument does hold, stock return fluctuations should be lower under divided than under unified government. Our results confirm that divided government has a volatility reducing effect on the German stock market. This supports the view that divided government lowers policy risk.
Keywords: Divided Government, Economic Policy, Financial Risk, Volatility, Stock Markets
JEL Classification: P16, N2
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Election Polls, Free Trade, and the Stock Market: Evidence from the Canadian General Election
-
Elections and Markets: The Effect of Partisanship, Policy Risk, and Electoral Margins on the Economy
-
By Roland Füss and Michael M. Bechtel
-
The Political Sources of Systematic Investment Risk: Lessons from a Consensus Democracy
-
Political Uncertainty and Stock Market Returns: Evidence from the 1995 Quebec Referendum
By Marie-claude Beaulieu, Naceur Essaddam, ...
-
Endogenous Election Timings and Political Business Cycles in Japan
-
Political Risk and Stock Returns: The Case of Hong Kong
By Harold Y. Kim and Jianping Mei