International Financial Markets, Electoral Uncertainty, and Economic Performance

• In Event: Politics of International Finance

Abstract

What are the real economic consequences of electoral uncertainty? Existing research documents how elections affect financial asset prices, but less is known about the effects of election-induced uncertainty on real economic outcomes. This study shows that short-run uncertainty about the election outcome has transient effects on financial markets, but long-run election-induced policy uncertainty has persistent effects on real economic activity. I estimate the effect of short- and long-run electoral uncertainty using implied volatility data from equity options markets—a forward-looking measure that captures international investors’ uncertainty over a wide range of time horizons—for a sample of developed and emerging economies. The results show that elections produce not only short-run market volatility as previously documented, but, more importantly, long-run economic policy uncertainty that translates into lower levels of business confidence, private investment, and GDP growth. The findings shed new light on the impact of electoral uncertainty on capital allocation and national economic performance.

Author

• Raphael Cunha, King's College London