Precarious politics and return volatility

We examine how local and global political risks affect industry return volatility. Our central premise is that some industries are more sensitive to political events than others. We find that industries that are more dependent on trade, contract enforcement, and labor exhibit greater return volatility when local political risks are higher. Political uncertainty in countries of trading partners of trade-dependent industries similarly results in greater volatility. Volatility decomposition results indicate that while systematic volatility is associated with domestic political uncertainty, global political risks translate into larger idiosyncratic volatility. (JEL G10, G15) On September 29, 2008, the U.S. House of Representatives voted down the bailout bill proposed by the Treasury and the Federal Reserve in order to provide extra liquidity to the troubled U.S. financial markets. Within two hours the Chicago Board Options Exchange Volatility Index increased by 17%, while in one day the Dow Jones Industrial Average Index dropped 778 points. Global stock markets reacted in a similar fashion.1 Clearly, the uncertainty about the outcome of a critical vote was reflected by both domestic and global stoc