Year of Graduation
The Investigation of the Impact of Political Instability on the Volatility of Stock Markets
Financial Markets and Financial Institutions
One of the key factors, which tells political risk apart from financial risk is the fact that its increase does not lead to the increase of returns (Diamonte et al., 1996; Perotti and van Oijen, 2001; Lehkonen and Heimonen, 2015). Therefore, an increase of political risk should not be interpreted by market in a similar way to an increase of financial risk. In order to examine the mechanism of the relationship between the volatility of stock market returns and the increased political instability, this study conducts regression analysis on panel data covering 42 developed and emerging financial markets during the period 31.12.1996-31.12.2017. The political risk rank developed by ICRG PRS and its components serve as proxies for political instability. The findings do not suggest any straightforward relationship between the examined variables. In particular, the results imply that the political risk is insignificant for investors’ perception of financial risk on the whole sample. This result also holds for the sample of emerging countries, which implies that investors could be prepared to taking political risks in these economies and therefore they do not surprise them. However, political risk is reducing the volatility of stock market returns on a sample of developed economies. Such result may suggest that the investors view an increase of political risk (given it is generally very low) as a sign of establishment of geopolitical dominance or as a quest for further improvement of the institutions by the means of peaceful protests and functioning civil society.