This paper claims that investors dislike political uncertainty about future policies and value stability in the political environment.
We test the validity of this hypothesis by first studying variations in equity flows from global investment funds to emerging markets in periods surrounding elections.
Second, we interpret changes in democracy score as another event potentially creating political uncertainty and assess their effects on equity flows. Our results corroborate our hypothesis. They indicate that the period following an election is generally characterized by a fall in equity flows, and that this occurs only where the incumbent is not re-elected, suggesting continuity is valued by investors.
We also find that this effect is confined to presidential regimes, a result we interpret as further evidence that potentially radical swings in policy affect investors’ choices.
Finally, a decrease in the democracy score implies lower equity flows, while democracy in itself does not affect equity flows, which is consistent with our view that equity funds are vigilant when potentially adverse changes in the political environment arise.