Stock Price Volatility and Political Uncertainty: Evidence from the Interwar Period
41 Pages Posted: 18 Mar 2002
Date Written: February 2002
The extreme levels of stock price volatility found during the Great Depression have often been attributed to political uncertainty. This paper performs an explicit test of the Merton/Schwert hypothesis that doubts about the survival of the capitalist system were partly responsible. It does so by using a panel data set on political unrest, demonstrations and other indicators of instability in a set of 10 developed countries during the interwar period. I show that political risks themselves changed dramatically over the period, and are sufficient to account for a large part of the increase in volatility during the Great Depression. This conclusion is robust to a number of alternative specifications. I derive rolling estimates of the risk of revolution, and demonstrate that the strong reaction to incidents of worker militancy such as strikes and riots can be rationalized as a sensible reaction to the risk of expropriation.
Keywords: Stock price volatility, political uncertainty, worker militancy, Great Depression
JEL Classification: G12, G14, G18, E66, N22, N24, N12, N14
Suggested Citation: Suggested Citation