Phillips, Lauren M
(2006)
Political risk in emerging market economies: Democratic politics, sovereign debt and financial market volatility in Brazil and Mexico.
PhD thesis, London School of Economics and Political Science.
Abstract
While the literature on the globalisation of financial flows has focused on the impact of highly mobile capital on domestic political choice and policy variation, less has been said about the impact of democratic politics on financial market performance. Existing studies have tended to limit their analysis to the impact of elections on markets. This thesis re-examines standard notions of political risk, hypothesising that political risk arises from the contours of democratic institutions, and suggests that institutions play a direct, rather than secondary, role in generating financial market volatility through the production of political news. A quantitative approach is adopted to examining both static and dynamic perceptions of market risk across emerging market countries, with particular focus on Brazil and Mexico. Democratic political risk is defined as the uncertainty and instability arising from contestation over power and policy, which is more likely to occur in states with many veto players who have diverse policy preferences and low internal cohesion. States with such institutions are more likely to produce high levels of political news, in turn interpreted by market participants as political risk. The impact of such news is likely to be greater than that of other information significant to the market given the unpredictability and uncertainty of political information, as well as the difficulties in quantifying its impact. By examining the empirical determinants of sovereign bond spreads, as well as the causes of volatility in Brazilian and Mexican bond markets, the thesis demonstrates that political variables add significant explanatory power to models of sovereign debt premiums and that financial markets are highly reactive to democratic politics in emerging market countries.
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