Policy Uncertainty, Electoral Securities and

This paper investigates how uncertainty about the adoption of a redistri-bution policy affects political support for redistribution when individuals can trade policy-contingent securities in the stock market. I show that in equilib-rium the support for redistribution is always smaller than in the case where no “policy-insurance market ” is available. Consistent with the empirical evidence, the analysis implies that in economies with well-developed financial markets the level of redistribution decreases with the level of participation in these markets and with income inequality. I show that the existence of a policy-insurance mar-ket may lead to a less equal equilibrium distribution of income than in the case where no insurance is available even if a majority of individuals are redistributing resources through private transfers. ∗I am grateful to Bob Inman, Andrew Postlewaite, Frank Schorfheide and in particular to Antonio Merlo for their comments and encouragement. I also would like to thank Mike Alvarez, Marco Cozzi