When Investors Enjoy Less Policy Risk: Divided Government,Economic Policy Change,and Stock Market Volatility in Germany, 1970‐2005 |
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| Authors: | Michael M. Bechtel Roland Füss |
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| Affiliation: | 1. University of Konstanz and European Business School(EBS);2. Michael Bechtel is a Ph.D. Candidate in the Department of Politics and Management at Konstanz University and grantee of the German National Merit Foundation. His research focuses on international) olitical conomy.;3. Roland Füss is Professor of Finance and holds the Union Investment Endowed Chair of As‐ set Management at the European Business School(EBS), International University ‐ Schloss Reichartshausen. His research focuses on alternative investments, risk management, political economy of financial markets, and applied time series econometrics. He has (co‐)authored numerous articles in financial economics, finance, and political science journals. |
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| 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. |
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| Keywords: | Divided government Gridlock Spatial model Policy risk Stock market Volatility Germany GARCH Modeling |
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