Democratization, Inequality, and Risk Premia

Abstract

Periods of democratization exhibit economically large spikes in risk premia. In a panel data set covering 85 countries over 200 years, several proxies for risk premia are significantly elevated during periods of democratization, despite little to no effect on aggregate consumption and dividends. This result is explained in an asset pricing model in which wealthy asset market participants must redistribute their income if democracy consolidates. Finally, in a quasi-natural experiment emanating from a shift in Catholic church doctrine in support of democracy in 1963, average returns were significantly higher for majority Catholic autocracies relative to control countries in a triple difference-in-differences framework. These results are key to understanding how political institutions and the distribution of economic and political power influence asset returns.

Keywords: Risk Premia, Democratization, Inequality, Political Institutions, Catholic Church

JEL Classification: G10, G15, G18, N40, P16