Is There a Democratic Premium? Elections and Financial Markets in Emerging Economies

Abstract

We explore whether elections have an effect on portfolio flows only when they create political uncertainty. Such findings give policymakers some room of maneuver. Political uncertainty can be quickly resolved and portfolio flows return to previous levels within an average of eight months after an election. While this is a relatively short period, the economic costs may still be substantial, the worsening around election times being frequently severe, at least in the 1990s decade.Politicians can take steps to reduce political uncertainty, by making their intentions clear. They can reduce the incongruous information foreign investors face by publicizing their political agenda to the financial in the country as well as to their citizens. Another option is for politicians to send a message of credibility and policy options by trying the hands of the electoral candidates ex ante through the pre-electoral commitments binding them to implement “market friendly” reforms. We look at the experience of Latin America in this respect.