Counting the Investor Vote: Political Business Cycle Effects on Sovereign Bond Spreads in Developing Countries

• Main Authors: Vaaler, Paul M., Schrage, Burkhard N., Block, Steven A.
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2010
• Subjects: International Business
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/2693
• Institution: Singapore Management University

International business research has paid scant attention to whether and how electoral politics and economic policies affect foreign investment risk assessment, particularly in developing countries, where the last decade has seen both considerable foreign investment and domestic progress toward democratization and electoral competitiveness. We respond with development and testing of a framework using partisan and opportunistic political business cycle (PBC) theory to predict the investment risk perceived by investors holding sovereign bonds during 19 presidential elections in 12 developing countries from 1994 to 2000. Consistent with our framework, we find that bondholders perceive higher (lower) investment risk in the form of higher (lower) credit spreads on their sovereign bonds as right-wing (left-wing) political incumbents appear more likely to be replaced by left-wing (right-wing) challengers. For international business research, our findings illustrate the promise of PBC theory in explaining the election-period behavior of sovereign bondholders and, perhaps, other investors who also 'vote' in developing country elections and can substantially influence the price and availability of capital there. For developing country investors and states, our findings highlight the financial effects of democracy in action, and underscore the importance of state communication with investors during election periods.