Do new government leaders really matter for financial markets?

comments 0






Rakesh Rana's picture


Yes they do! New government leaders usually come in with new ideological stance; they promise sweeping changes which quite often alters the course of given countries economic, fiscal and diplomatic policies. All these changes can significantly affect the potential growth and profitability of firms operating in these markets – thus new government leaders do matter to financial markets. In this paper we review research and theories related to this topic and provide further empirical evidence from recent elections in the emerging countries to demonstrate that new government leaders do matter to financial markets.


Introduction, Theory and Related Work

Policy Uncertainty and Asset Prices

Using observations from 21 countries, Brogaard and Detzel (Brogaard & Detzel 2012) found that for each percentage point increase in economic policy uncertainty, contemporaneous market returns fall by 2.9% and market volatility increases by 18%. The aggregate cash flows shift downwards, returning to normal after one quarter. The study suggests that indecisiveness in government economic policymaking has long standing real and financial implications.

Uncertain Information Hypothesis (UIH)

Brown et al. (Brown et al. 1988) proposed uncertain information hypothesis to explain response of risk-averse investors to an unanticipated information. According to the proposed theory – both the risk and expected return systematically increases following news of a dramatic financial event. Further using empirical evidence from over 9000 market-wide and firm-specific events, the study also showed that prices react more strongly to bad news than they do for good news.

Election model of Harrington (1993)

Harrington (Harrington Jr 1993) examined the role of re-election pressure in determining the economic policy of incumbent politician. The study suggests that electoral outcomes are influenced by both (i.) Incumbent politician’s past policies and (ii.) level of economic activity. The more uncertain the voters are about which policy is best, the higher the impact of level of economic activity. And less sensitive the voters are to economic performance relative to policy, incumbent is more likely to manipulate the policies s/he believes would be well received rather than maximizing the expected income. 

Empirical evidence from OECD countries

Pantzalis et al. (Pantzalis et al. 2000) analysed behaviour of stock market of 33 OECD countries around political election dates between 1974-95. The authors found positive abnormal returns for two-weeks leading to the election week. The positive abnormal returns were particularly strong for (a.) less free countries where the election was lost by incumbent government, and (b.) when the incumbent government called early elections and lost. The results from the study were in agreement to Brown et al.’s (1988) UIH hypothesis and Harrington’s (1993) model of election behaviour.

Thomas Sattler (Sattler 2013) from LSE used stock market reaction to 205 elections since 1950s to confirm earlier research findings (for example (Herron 2000; Leblang & Mukherjee 2005; Bechtel 2009)) that show stock markets often drop significantly after left-wing government victory, while the movement is upwards when the incoming government is right-wing. The partisan effect on stock market has been shown to be persistent and also become stronger with time when more information is available with respect to the incoming government composition.

Thomas Sattler (Sattler 2013) further provide evidence that this reaction is strongly dependent on the political constraints faced by the incoming government – the partisan effect on stock market disappears for cases where political constraints are high. The explanation - institutional framework of a country and its consequent political constraints limits the ability of new government to alter existing policies and implement those closer to their ideology (Henisz 2004).

In summary, political elections and thus emergence of new government leaders matter and it matters significantly for financial markets as well as for the individual countries economic development.


Evidence from Asia (India)

Seven elections from India

To test if the evidence of abnormal returns observed for OECD countries during election period hold for emerging countries, we analysed seven general election held in India over the period 1990-2015. The countries’ most widely reported index, S&P BSE Sensex movement over the period is presented in Figure 1 with overlay of dates of general elections result announcement during this period. The daily average return for seven elections held in India during the studied period is presented in Figure 2.

Figure 1: S&P BSE Sensex over the period 01-Jan-1990 to 01-Jan-2015.


Figure 2: The chart showing average daily return for (a.) two week period prior to marked date (t-2w:t), (b.) baseline of 10 weeks prior to test window (t-12w to t-2w), and (c.) two weeks post the marked date (t:t+2w).

It is observed that there is considerable difference in average daily return for both pre- and post- two weeks period to date of general elections compared to the baseline period (ten weeks prior to test window). The results are consistent with (Pantzalis et al. 2000) observation of abnormal returns during election dates and that such returns are stronger for less free countries.

Recent victory of India’s pro-business Narendra Modi

Conditions in which new leaders matters even more (from theoretical as well as practical perspective) are, when they come with considerably different ideological mind-set than the incumbent government.

One recent example of such a change is seen in 2014 Indian election, where Narendra Modi succeeded with most resounding election victory India has seen in 30 years (Singh & Shah 2014). The election also recording the highest ever electoral turnout of 66.38% ( BBC News, 2014). The incoming party nearly wiped out the ruling Congress party alliance that has been in power for a decade. The incumbent government has been mired in serious corruption scandals and ineffective leadership (BBC News, 2014). Consistent with theory and earlier observations, Modi’s victory show strong positive reaction from the financial markets.

In the first six months of the new government in the leadership of Narendra Modi, a number of strategic shifts in economic policies and foreign affairs is observed, most evidently among these were (Mail Today Bureau, 2014):

  • Economic policies
    • Ordinance for re-allocation of cancelled coal blocks,
    • Liberalisation of foreign direct investment (FDI) in defence, railways, real estate and insurance,
    • Launched ‘Make in India’ campaign - to promote manufacturing in India,
    • Major decisions on investments in energy and transport sector among others, and
    • Finding the workaround to seal civil nuclear deal with the U.S (Chalmers 2015).
  • Diplomacy and foreign policy
    • Strengthening Indo-US ties, inviting US President Barack Obama as chief guest for the Republic Day – a first time a U.S. leader will grace India’s Republic Day celebrations as a chief guest (Pant 2014),
    • Successful trips to eight countries. US, Japan, Brazil, Bhutan, Japan, Australia, Myanmar and Fiji, and
    • Specific focus to strengthen its relations with neighbours and handling relationships with Pakistan with open for dialogue but firm stance on boarder issues.

These six months in office of new government was a large shift from policy paralysis that marked the incumbent government rule it replaced. Although it’s early to give a firm verdict on Modi’s government performance, but it is clearly evident that new leaders can bring in large swings in economic and diplomatic policies of a country which impacts highly on the financial markets – thus new government leaders do matter to financial markets.


Evidence form emerging countries fragile five countries election results

Finally to strengthen the empirical evidence, we further analysed average daily returns over recent elections in emerging markets fragile five[1] countries. The daily average return during recent elections in these countries is presented in Figure 3.

Figure 3: Chart showing average daily return for two weeks prior-, ten weeks baseline and two weeks post- election period for elections held in 2014 among emerging countries fragile five.

The results illustrated in Figure 3, further strengthen the evidence that new government leaders do matter. The abnormal returns pre- and post- elections of new government leaders do hold for recent elections held in emerging countries in year 2014. In Brazil, re-election of incumbent leader President Dilma Rousseff over pro-business Aecio Neves resulted in large negative return leading to the announcement of results as the victory of incumbent became clearer. Similarly in Turkey, victory of ruling party candidate to Presidency raised concerns on interest-rate cuts leading markets to react negatively. The sharp reactions leading to elections in both countries also lead to some corrections post- these leaders taking office. On the other hand pro-business leaders win over incumbent governments in Indonesia and India show sharp positive reactions from financial markets as their victory became evident in run up to the date of their success. 



The theory and empirical evidences strongly support the hypothesis that new government leaders matter to financial markets. By bringing in new ideological perspective and potential changes to economic and fiscal policies of the country – new government leaders can greatly impact the business environment and growth opportunities of firms operating in the market, thus financial markets keenly observe the rise/fall of such leaders and they matter them significantly.


[1] Emerging markets so-called “fragile five” countries – Brazil, South Africa, Indonesia, India and Turkey (Kynge 2014)


Bechtel, M.M., 2009. The political sources of systematic investment risk: lessons from a consensus democracy. The Journal of Politics, 71(02), pp.661–677.

Brogaard, J. & Detzel, A., 2012. The asset pricing implications of government economic policy uncertainty. University of Washington mimeo. Available at: [Accessed January 24, 2015].

Brown, K.C., Harlow, W.V. & Tinic, S.M., 1988. Risk aversion, uncertain information, and market efficiency. Journal of Financial Economics, 22(2), pp.355–385.

Chalmers, 2015. U.S., India find workaround to seal civil nuclear deal - media. Available at: [Accessed January 25, 2015].

Harrington Jr, J.E., 1993. Economic policy, economic performance, and elections. The American Economic Review, pp.27–42.

Henisz, W.J., 2004. Political institutions and policy volatility. Economics & Politics, 16(1), pp.1–27.

Herron, M.C., 2000. Estimating the economic impact of political party competition in the 1992 British election. American Journal of Political Science, pp.326–337.

Kynge, J., 2014. EM’s “fragile five” back under pressure. Financial Times. Available at: [Accessed January 25, 2015].

Leblang, D. & Mukherjee, B., 2005. Government partisanship, elections, and the stock market: examining American and British stock returns, 1930–2000. American Journal of Political Science, 49(4), pp.780–802.

Mail Today Bureau, 2014, Narendra Modi’s 6-month report card: Hits and misses. Yahoo News India. Available at: [Accessed January 25, 2015].

BBC News, 2014, News, S.M.B. & Delhi, India’s Modi hails “landmark” win. BBC News. Available at: [Accessed January 25, 2015].

Pant, H., 2014. Modi’s Diplomatic Chutzpah. The Diplomat. Available at: [Accessed January 25, 2015].

Pantzalis, C., Stangeland, D.A. & Turtle, H.J., 2000. Political elections and the resolution of uncertainty: the international evidence. Journal of banking & finance, 24(10), pp.1575–1604.

Sattler, T., 2013. Do markets punish left governments? The Journal of Politics, 75(02), pp.343–356.

Singh, R.K. & Shah, A., 2014. India’s pro-business Modi storms to historic election win. Reuters. Available at: [Accessed January 25, 2015].