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When Investors Enjoy Less Policy Risk: Divided Government, Economic Policy Change, and Stock Market Volatility in Germany, 1970‐2005
Author(s) -
Bechtel Michael M.,
Füss Roland
Publication year - 2008
Publication title -
swiss political science review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.632
H-Index - 30
eISSN - 1662-6370
pISSN - 1424-7755
DOI - 10.1002/j.1662-6370.2008.tb00104.x
Subject(s) - gridlock , economics , volatility (finance) , stock market , divided government , stock (firearms) , financial economics , monetary economics , fiscal policy , legislature , economic policy , mechanical engineering , history , paleontology , archaeology , horse , politics , political science , law , biology , engineering
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.