Flight to Quality in International Markets: Investors’ Demand for Financial Reporting Quality during Political Uncertainty Events

66 Pages Posted: 20 Jan 2015 Last revised: 5 Nov 2017

See all articles by Feng Chen

Feng Chen

University of Toronto - Rotman School of Management

Ole-Kristian Hope

University of Toronto - Rotman School of Management

Qingyuan Li

Wuhan University - School of Economics and Management

Xin Wang

The University of Hong Kong

Date Written: August 9, 2016

Abstract

We examine whether international equity mutual-fund managers shift their portfolios toward stocks with higher financial reporting quality during periods of high political uncertainty. Our study is motivated by two primary factors. First, prior research shows evidence of fund managers’ “flight to quality” (e.g., to less risky securities) during periods of uncertainty. Second, recent theoretical research concludes that stocks with higher financial reporting quality are assessed as less sensitive to systematic risk (such as political uncertainty). We employ national elections as exogenous increases in systematic risk in the local markets and accordingly use an international sample of mutual funds that focus on local markets. We find that mutual-fund managers shift their equity holdings to stocks with higher financial reporting quality during election periods when political uncertainty is higher. Such a flight-to-quality effect is less pronounced for elections with larger expected electoral margins in the pre-election period (i.e., when the incumbent is more likely to win the election) and for countries with higher transactions costs. In contrast, the effect is more pronounced when governments have greater involvement in the local economy. Our inferences are robust to alternative proxies for political uncertainty and financial reporting quality and to numerous other sensitivity analyses.

Keywords: Political uncertainty, National elections, Flight to quality, Financial reporting quality, International mutual funds

JEL Classification: G30, G31, G34, G20, M41, F00, F20, F21, F30

Suggested Citation

Chen, Feng and Hope, Ole-Kristian and Li, Qingyuan and Wang, Xin, Flight to Quality in International Markets: Investors’ Demand for Financial Reporting Quality during Political Uncertainty Events (August 9, 2016). Rotman School of Management Working Paper No. 2552173. Available at SSRN: https://ssrn.com/abstract=2552173 or http://dx.doi.org/10.2139/ssrn.2552173

Feng Chen

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

Ole-Kristian Hope (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

HOME PAGE: http://www.rotman.utoronto.ca/FacultyAndResearch/Faculty/FacultyBios/Hope.aspx

Qingyuan Li

Wuhan University - School of Economics and Management ( email )

Wu Han, Hu-Bai 430072
China

Xin Wang

The University of Hong Kong ( email )

1215 K.K.Leung Building
Hong Kong
Hong Kong

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