Democratization, Inequality, and Risk Premia

Abstract

Risk premia are significantly elevated during periods of democratization in a cross-country panel of equity data covering 85 countries over 200 years, despite little effect on GDP or dividends. This result is explained in an asset pricing model in which wealthy asset market participants face redistribution if democracy consolidates. Finally, in a quasi-natural experiment emanating from a shift in Catholic church doctrine in support of democracy, majority Catholic autocracies display significantly higher average excess returns relative to other countries in a difference-in-differences framework. These results are key to understanding how the redistribution of economic and political power influence financial decisions.

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

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