Electoral management, political risk and exchange rate dynamics: the Greek experience

The paper tries to clarify whether the Greek drachma exchange rate movements could be better understood by incorporating the dynamics of the political environment. Greece could be considered as an ideal laboratory to examine the impact of the elections on the drachma exchange rate dynamics, since its political environment is formed by the co-existence of three distinct characteristics: first, a partisan structure with two main political parties with well defined ideological differences. Second, an opportunistic structure with frequent pre-electoral relaxation of monetary and fiscal policy, and, third, a high density of elections. Based on the assumption that foreign and domestic investors are sensitive to changes in political regime, the Greek foreign exchange rate is examined relative to the ECU and the US dollar. It is found that the incorporation of political variables in the form of the electoral cycle impact the volatility of the exchange rate. Specifically, with the incorporation of political variables in an EGARCH-M context, it is found that past innovations exert an asymmetric impact on the conditional volatility of the exchange rate relative to ECU and USD. Moreover, the results based on the six parliamentary elections suggest that the conditional variance of the exchange rate is impacted by political developments in Greece.