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Comparative politics and quasi-rational markets

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  • Iain McMenamin
  • Michael Breen
  • Juan Muñoz-Portillo

Abstract

This article synthesises psychology, economics and political science theories that can explain market reaction to elections. In order to test the theories, we conduct event studies of the impact of elections on the interest rates on government bonds for 122 elections in 19 countries. The efficient market hypothesis states that rational markets immediately incorporate all information relevant to asset prices. According to psychology, human decision-making is quasi-rational. Market actors should be slow to accept evidence that conflicts with previously held opinions, leading them to under-react to new information. We show that markets under-react to elections and that under-reaction is greater in majoritarian countries because they provide more information to the market. Assuming fully rational markets underestimates the impact of elections and variations in impact across political systems. Most of the literature on market constraint assumes rational markets and may thus be underestimating the extent of market pressure in the aftermath of elections and its distribution across different types of electoral systems. Our results suggest that markets can calculate risk around elections, but are slow to do so, thereby suggesting that the role of uncertainty and the resort to heuristics is relatively minor.

Suggested Citation

  • Iain McMenamin & Michael Breen & Juan Muñoz-Portillo, 2016. "Comparative politics and quasi-rational markets," New Political Economy, Taylor & Francis Journals, vol. 21(6), pages 587-605, November.
    • Handle: RePEc:taf:cnpexx:v:21:y:2016:i:6:p:587-605
    DOI: 10.1080/13563467.2016.1183114
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    References listed on IDEAS

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    1. Jeffrey M Wooldridge, 2010. "Econometric Analysis of Cross Section and Panel Data," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262232588, April.
    2. Torsten Persson & Guido Tabellini, 2005. "The Economic Effects of Constitutions," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262661926, April.
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