When Investors Enjoy Less Policy Risk: Divided Government, Economic Policy Change, and Stock Market Volatility in Germany, 1970-2005
Journal
Swiss Political Science Review
ISSN
1424-7755
ISSN-Digital
1662-6370
Type
journal article
Date Issued
2008-07-01
Author(s)
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.
Language
English
Keywords
Divided government
Gridlock
Spatial model
Policy risk
Stock market
Volatility
Germany
GARCH Modeling
HSG Classification
contribution to scientific community
Refereed
Yes
Publisher
Rüegger
Publisher place
Zürich
Volume
14
Number
2
Start page
287
End page
314
Pages
28
Subject(s)
Eprints ID
216327