Mei and Political Crises a Review

This paper studies the impact of political risk on financial crises in emerging markets by examining political election cycles. The author tries to ascertain if there is a significant relationship between political elections and financial crises, defined by the abrupt shift from capital inflow to outflow between consecutive periods. He finds a significant relationship, with eight out of nine of the recent financial crises shown to have happened during periods of national elections. He also finds that political elections tend to increase volatility in emerging markets. Further, the author finds that a higher ratio of short-term debt to reserves is strongly associated with the onset of a crisis, but that the level of total debt is not statistically associated with a crisis[1]. The paper also finds that an important predictor of a crisis is the rapid build-up of bank claims, since this weakens the financial system and makes the country more vulnerable to a financial crisis.

This paper contributes to the existing literature on currency crises and equity market volatilities by identifying a new source of political uncertainty, political elections. Previously, there was little empirical study on the effects of political factors on stock prices and volatilities. Most research on crises and contagions looked at the impact of economic events on stock prices (see for example, Roll (1988) and Fama (1990)), with little regard for non-economic variables. The limited work in this area include Erb et al (1996), who discovered a positive relationship between political risk indicators and market volatility in emerging markets as measured by the ICPG political risk ratings and Bittlingmayer (1998), who also confirmed a close relationship between political risk and market volatility. This paper therefore fills an important niche by looking at how a specific non-economic variable such as national elections can provide additional lead to understanding how significant market movements...