Political Events, Capital Markets and Economic

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Political Events, Capital Markets and Economic Performances in a selected Countries

Sharlywest Uwabor EBOIGBE B.Sc. (Accounting) M.Sc. (Finance) ACA (Nigeria)



DECEMBER, 2016 1

Political Events, Capital Markets and Economic Performances in a selected Countries

Sharlywest Uwabor EBOIGBE B.Sc. (Accounting) M.Sc. (Finance) ACA (Nigeria)





DECLARATION I, EBOIGBE Sharlywest Uwabor declare that this PhD Finance Dissertation is original as all ideas, views and conclusions therein are the product of my research. The contributions of others have been duly acknowledged and referenced. This thesis has not been submitted in parts or full for any Diploma or Degree here or in any other University.


Sharlywest Uwabor Eboigbe CERTIFICATION We the undersigned certify that this thesis titled: Political Events, Capital Markets and Economic Performances: Testing Cycles within Cycle in a selected Economies” was carried out by Sharlywest Uwabor EBOIGBE in partial fulfilment of the requirement for the award of Doctor of Philosophy (Ph.D.) in Finance in the Department of Banking and Finance, Faculty of Management Sciences, University of Benin, Nigeria. And that it has successfully passed the antiplagiarism test as at 2ndDecember 2016 by 04:03PMand does not violate copyright regulations as indicated by Turnitin similarity index of 7%.









P.G. Representative, Faculty Management Sciences.



Head of Department, Banking and Finance. ATTESTATION We, the undersigned attest that Sharlywest Uwabor EBOIGBE has corrected the observations as recommended by the external and internal examiners in his dissertation titled: Political Events, Capital Markets and Economic Performances: Testing Cycles within Cycle in a selected Economies”





PROF. P.O.ERIKI PhD Internal Examiner



DR. A. E. UWUBANMWEN P.G. Representative, Faculty Management Sciences.




Head of Department, Banking and Finance. DEDICATION My awareness that I am a tourist and that Almighty God is my travel agent who knows and fixes my routes, reservation as well as the destination, this study is dedicated to HIM the author of knowledge for resuscitating a once condemned in the knowledge frontier. It is also dedicated it to my father Johnson Ajumabon Eboigbe (1919-2001), who never dreamt of a graduate child; my mother Madam Lucy Ehiwario Eboigbe, my permanent Room-mate Mrs Roselyn Enoyesere Eboigbe and my two wonderful children- Peculiar Oyendikachi and Eminence Osamuyimen.


ACKNOWLEDGEMENT Since knowledge is the beginning of understanding as well as the depth by which genuine accomplishment in life is determined, I therefore say glory be to Almighty God who authored it. Some see knowledge as obstacles while others sees it as pillars, but I see knowledge as symbol of hope based on its contributions to my life. On this premise I say thank you to Professors: Venerable Ifuero Osad Osamwonyi, Chinwuba Okafor, Peter O. Eriki and P.A Isenmila for your academic supervisory role in my pursuit of knowledge from undergraduate to Doctoral levels. Pessimism do not see opportunism as product of difficulties but optimist harnesses the opportunities embedded in difficult scenarios. In the light of this belief, I say thank you to the following personalities who did not mind my defective historical foundation as a child of illiterate parents from a shantytown: Oloi Osarugue Erediauwa (OMO NO BAZUAYE NE RIE), Professor Godwin Osayuki Oshodin, Rt. Hon. (Bar). Samson Osagie, Dr and Mrs Godwin Ehigiamusoe, Kenneth Ibhaluobe and Dr Joel Obayagbona. I will forever be grateful to my colleagues, staff and students of the Department of Banking and Finance and Faculty of Management Sciences, University of Benin for accepting my various deficiencies. Also on the list to be acknowledged are my colleagues at the stream 5 (five) PhD 7

Finance UNIBEN-Abudu Kasimu, Eguavoen Jeffery,Ogieva Osazee and Osayi Igbinadion for the oneness and the open-mindedness of our vision while the programme lasted. My boundless gratitude goes to my critics and those in whom mockery were evidenced, for without them, God would not have made me. Many thanks to Abidemi Adegboye for his unselfish, unreserved assistances and proficiency in the analysis of my data. At this point, I want to acknowledge the Divinity in Humanity that made this study and the student what they are today: Gen. (Dr) Samuel Osaigbovo Ogbemudia CON, through whom the parents of the author were well-looked-after during the Nigerian Civil war of 1966-1970.

ABSTRACT This research examines the relationship between political events and monetary policy indices such as inflation, interest and unemployment rates, the position of electoral events in capital market volatility transmission, changes in exchange rate, and index of industrial output of countries. Testing uncertainty information hypothesis by using the Nigerian capital market and the 2015 presidential election postponement was also a tool in this study. The study adopts the Generalized Method of Moment to handle heterogeneity and simultaneity that may exist between policy instruments over time, VECH, Bi-Variate GARCH (1, 1) to allow for a focus on the interdependence of the conditional changes adopted for the volatility transfer conditions and correlation. The traditional Market Model for market returns was also considered using panel data of the variables for these countries. The result of the study shows that opportunistic political business cycle exist in monetary policy with lowered interest rate and increased productivity in some of the countries studied. UK, Brazil, Egypt, RSA, Nigeria and China had average lower interest rate at pre compared with the post-election period, while USA, HK, Japan, France and Germany had higher rate of interest at 3 pre-election for the period studied. The study also revealed that past shock and volatility of exchange rates impact on the future volatilities of the stock market, these are less in Germany and 8

France. From the study, we also find that banking and petroleum sector stocks reveal a significant shocks in returns/variances from the various presidential elections in Nigeria.This implies the followings: that political parties pursue policies which sometimes strangulate output at postelections periods, perhaps by fighting inflation, which lead to deepening in stock market performance and returns; election postponement as an event tends to increase market volatility due to market uncertainty evidenced by the fact that the variance of returns being significantly higher for non-election days in Nigeria; and that there exist connectivity between political events and sectoral market performances. The study recommends amongst others that monetary regulatory agencies be granted full autonomy from the fiscal policy agents. The Europe model of apex bank for regional economic bloc is also recommended for nations within a region notable for weak institutional autonomy.















Table of Contents



1.1 Background to Study

1 9

1.2 Statement of Research Problem


1.3 Research Questions


1.4 Objective of the Study


1.5 Statement of Hypotheses


1.6 Scope of Study


1.7 Relevance of the Study


1.8 Limitation of the Study CHAPTER TWO: LITERATURE


2.1 Introduction


2.2 Theoretical Review


2.2.1 Political Monetary Cycles Theory


2.2.2 Political Business Cycles Theory


2.2.3 Opportunistic Political Business Cycles Theory


2.2.4 Partisanship Political Business Cycles Theory


2.2.5 Reverse Electoral Business Cycle Theory


2.2.6 Real Business Cycle Theory


2.2.7 Uncertain Information Hypotheses Theory


2.3 Empirical Review


2.3.1 Political Business Cycles and Monetary Policy



2.3.2 Political Business Cycles, Gross Domestic Product and Stock Market Prices


2.3.3 Electoral Cycle and Exchange Rate Movement


2.3.4 Stock Market Prices, Uncertainty Information Hypothesis and Market Efficiency


2.3.5 Election Business Cycles, Unemployment and Inflation


2.3.6 Elections and Specific Firms/Industry Stock Price Movement


2.3.7Empirical and Methodological Survey of Some Literatures


2.3.8 Schematic Relationship of Some Macroeconomic Indicators



3.1 Introduction


3.2 Research Design


3.3 Population and Sample size


3.4 Sources of Data


3.5 Theoretical Fundamentals and Model Specification


3.5.1 Opportunistic Political Business Cycle Model


3.5.2 Relationship between Market Volatility and Changes in Exchange Rate within PBC


3.5.3 Relationship between Partisanship/Governance Style and Market Returns


3.5.4 Relationship between Electoral Events and Specific Firms Market Returns


3.5.5 Abnormal Returns


3.5.6 Testing Procedure

55 11

3.5.7 Estimation Method


3.5.8 Operationalization of variables







Data Presentation


4.2.1 Data Stream




Data Analysis

4.3.1 Summary Statistics


4.3.2 Correlation Analysis


4.3.3 Econometric Analysis


4.3.4 Market Volatility and Changes in Exchange Rate within Political Business Cycles 83 Unit Root Test Results

83 Multivariate Analysis of Volatility Transmission


4.3.5 Partisanship/Governance Style and Market Returns


4.3.6 Uncertainty Information Hypothesis Test


4.3.7 Elections and Specific Firms/Industry’s Stock Returns in Nigerian Stock Market

91 Returns Estimations

92 Abnormal Returns

93 Empirical Analysis of the Cumulative Abnormal Returns (CAR)


4.3.8 Hypothesis Testing


4.3/9 Discussion of Findings



5.1 Summary of Findings



5.2 Conclusion


5.3 Recommendations


5.4 Contributions to Knowledge


5.5 Areas for Further Study






LIST OF TABLES 2.1 Table of outstanding studies and methodological survey


4.1A Descriptive Statistics of Macroeconomic Data


4.1B Descriptive Statistics of Macroeconomic Data and % changes (3 by 3 pre and 12 by12 post analysis)



4.1C Descriptive Statistics of Macroeconomic Data and % changes (12-3 month’s pre and 3-12months post analysis).


4.1D Macroeconomic Variables of Countries Reaction to Electoral window


4.1E Correlation Matrix of Variables


4.2A Asymmetries Before and After Elections


4.2B percentage changes in Asymmetries Before and After Elections


4.3AAsymmetries before elections given output above or below potential


4.3B percentage changes in Asymmetries before elections given output above or below potential.


4.4AAsymmetries after elections given output above or below potential


4.4B percentage changes in Asymmetries after elections given output above or below potential.


4.5AAsymmetries before and after elections given output above or below potential restricted results)


4.5B Percentage changes in Asymmetries before and after elections given output above or below potential (restricted results)


4.6 Unit Roots Tests Results


4.7 Volatility Transmission Results


4.8 Test of Conditional Correlation Shifts between Exchange rate and Stock


87 4.9 Parties and Stock Returns


4.10 Election Postponement and Stock Returns in Nigeria


4.11 Variance difference results

91 14

4.12 Estimates of the α’s and β’s for each of the Firms 4.13(a) Abnormal Returns for the Firms, 1999 (10 days Pre-and post-elections)

93 94

4.13(b) Abnormal Returns for the Firms, 2003 (10 days Pre- and post-elections)


4.13(c) Abnormal Returns for the Firms, 2007 (10 days Pre- and post-elections)


4.13(d) Abnormal Returns for the Firms, 2011 (10 days Pre- and post-elections)


4.14 Cumulative Abnormal Returns for Presidential Election Periods, 1999-2011



2.1 Schematic Relationship of Macroeconomic Indicators (internal and external)



2.2 Schematic Relationship of Macroeconomic Indicators (internal)


2.3 Schematic representation of the study


4.1a Interest Rate for 12-Months Before, 3-Months Before, 3-Months after and 12-months after


4.1b Output Growth for 12-Months Before, 3-Months Before, 3-Months after and 12-months after


4.1c Inflation Rate for 12-Months Before, 3-Months Before, 3-Months after and 12-months after


4.2a Asymmetries Before and After Elections (Interest Rate)


4.2b Asymmetries Before and After Elections (Output Gap)


4.2c Asymmetries Before and After Elections (Inflation Rate)


4.3aAsymmetries before elections given output above or below potential (Interest Rate) 77 4.3bAsymmetries before elections given output above or below potential (Inflation Rate) 77 4.3cAsymmetries before elections given output above or below potential (Output Gap)


4.4a Asymmetries after elections given output above or below potential (Interest Rate)


4.4b Asymmetries after elections given output above or below potential (Inflation Rate) 80 4.4c Asymmetries after elections given output above or below potential (Output Gap)



4.5a Asymmetries before and after elections given output above or below potential (Interest Rate)


4.5b Asymmetries before and after elections given output above or below potential (Interest Rate)


4.5c Asymmetries before and after elections given output above or below potential (Interest Rate)


4.6 Conditional Correlations (Exchange Rate and Stock Prices)



APPENDICES Appendix A. Ordinary least square result


Appendix B. Countries and political Election events dates


Appendix C. Macroeconomic Data of the countries studied


Appendix C. Monthly MSCI of the countries studied


Appendix D.NSE Daily stock prices Ten days to 1999 Election


Appendix D.NSE Daily stock prices Ten days after 1999 elections


Appendix D.NSE Daily stock prices Ten days to 2003 Election


Appendix D.NSE Daily stock prices Ten days after 2003 Election


Appendix D.NSE Daily stock prices Ten days to 2007 Election


Appendix D.NSE Daily stock prices Ten days after 2007 Election


Appendix D.NSE Daily stock prices Ten days to 2011 Election


Appendix D.NSE Daily stock prices Ten days after 2011 Election



CHAPTER ONE INTRODUCTION 1.1 Background to the study Electoral cycle’s relationship with monetary and fiscal policy in traditional business cycles and state of the economy are very important to rational voters, investors as well as rating agencies. The state encompasses before, during and after each polls. This is due to the influence of political business cycle (PBC) activities on a nation’s economy. Since economic indices and other performance indicators depend on incumbents’ political and economic ideology, a critical appraisals of these activities is of essence to stakeholders. Macroeconomic indicators like unemployment rates, interest rate, inflation rate, all share index and market capitalization as well as exchange rate have links with electoral events. This is predicated on our definition of politics as the authoritative allocation of values. The capital market performs a wide range of functions through trading, investment, speculation, hedge fund raising as well as arbitrage opportunities. It also acts as price discovery and information dissemination channels, which are the resultant effect of volatile human expectations with shift in supply and demand lines. Through these price oscillation, cyclical patterns manifest with eventual effect on returns. These human and system interactions are responses to specifics within the economy. Politics is one of those specifics. Political cycles affect national economy and financial market through institutional and regulatory functions. These include judicial pronouncements in courts, tax administrative efficiency, expansionary and contractionary fiscal and monetary policies. Stovall, (1992), Gartner and Wellershoff, (1995) see presidential business cycle as a phenomenon where stock prices fall during the first half of a


presidential term in office. This is evidenced by a trough in the second year, reaching a peak in the third or fourth year. This indicate low returns in the first two years and high returns in the later years. This they call stock market four-year cycle with varying length. The financial strength of any nation hinges on the strength of her financial market, which comprises stock market, bond market, derivatives and foreign exchange market Szylar, (2014). The behavioural relationship between investors and politics is based on the concept of political risk driven by changes in public policy that affect investment values, increase uncertainty during political windows particularly general elections (Bernhard & Leblang, 2002; Brooks & Mosley, 2008; Savita & Ramesh, 2015). National economic indices (fiscal and monetary), ruling political party’s ideology, national performance (GDP) coupled with capital market performances are therefore inextricably linked. These, to researchers are driven partly by information transmission within and outside the capital market environment, macroeconomic policy direction of the incumbent administration, investors’ confidence as well as international perception of the government in power. Governments’ discretionary power to levy taxes and charges, marketenhancing regulations and future policies affecting the Business cycle lend credence to the interplay in the political economy. This is further reinforced by changes in government philosophy, party policy and the incumbent political ideology. Political events which usually impact on the stock market and national economic activities include electoral related announcements such as regulation promulgation, law amendments and fear of the unknown (Hibbs, 1977; Snowberg, Wolfers, Zitzewitz, 2007; Fuss & Bechtel, 2008; Shelton, 2010; Eriki & Eboigbe, 2012). Block and Vaaler, (2004), Vaaler, Schrage and Block, (2006), Kaplan, (2010) summarise that elections-inspired uncertainty leads to rating downgrade. Therefore, there is the propensity for incumbents to 20










creditworthiness. 1.2 Statement of the Research Problem The interrelatedness of politics and economics is supposedly based on two issues: these are the extent to which economic conditions impact on voters’ behaviour as well as the political environment and its impact on government economic policies. This conjecture validates party’s popularity function and policy-reaction function (Taylor, 2000). This is in consonance with Frey and Schneider (1978) that economic event affect presidential popularity. This unending debate over the connectivity of partisan effects of macroeconomic objectives, political events and firm’s political contributions to government bring to the fore the concept of behavioural finance (Golden & Poterba, 1980; Jayachandran, 2006; Knight, 2007; Mukherjee & Leblang, 2007). Knight (2007) reveals that policies in a party’s platform transmit positive incremental values into equity prices through returns from industries favoured by a particular party. Roberts (1990), Santa-Clara & Valkanov (2003) and Sy & Al Zaman (2011) aver that politically determined events manifest at both macro and microeconomic levels. This they demonstrate with the death of very senior and influential Washington senator resulting in lower abnormal returns for firms where he had a stake implying that seniority and specific client-firms relationships are building block for firms’ performances. Connection to a politician means where one or more of the company directors have same educational and religious background with the key actors in government from which they can draw economic advantage. This, sometimes manifests with political actors having units of corporate ownership in the firms. It can also be seen with different employment arrangements in politically disadvantaged areas to the government in power. Here, new jobs and plants are established despite 21

unproductive product lines within the election window (Kramarz & Thesmar, 2007; Bertrand, Kramarz, Schoar & Thesmar, 2008; Cohen, Frazzini & Malloy, 2008; Fracassi, 2009; Do, Lee, Nguyen & Nguyen, 2012; Nguyen, 2012). Such political turnover substantially diffuses into the stock market performance of politically linked firms. These aforementioned are validated in literature with positive relationship (Fisman, 2001; Kroszner and Strahan, 2001; Bunkanwanicha and Wiwattanakantang, 2009; Aggarwal, Meschke and Wang, 2008; Boubakri, Cosset and Saffar, 2008; Guner, Malmendier and Tate, 2008; Goodell and Vahamaa, 2013). Politically connected firms’ impact negatively on aggregate demand and supply thereby shifting the market equilibrium before and after electoral events. This assertion is not without opposition, as Bertrand, Kramarz, Schoar and Thesmar, (2007) argue against political connectedness and firms’ performance. The other school of thought avows neutrality of political inclination of owners to firm turnover Fisman, Fisman, Galef and Khurana, (2006). Since politics is the fulcrum around which economy revolves, stakeholders ought to monitor politicallymotivated risks so as to determine electoral impact on national polices. Considering the linkage between elections and the economic wellbeing of domestic firms, governance culture, trade and military conflicts, studies show that war has significant negative effects on cross-border trading. This impedes business transaction involving financial assets and sovereign bonds. When foreign portfolio investments are distorted, the spill-over effect on the national economic parameters is enormous. This results in reduced gross domestic product and high capital flights powered by divestments of foreign portfolios (Blomberg and Hess, 2006, Glick and Taylor, 2010; Acemoglu and Yared, 2010). Partisanship and governance style affects market movement, hence it is a veritable predicting economic tool for GDP growth, trade balances, and inflation as well as unemployment


rates. The reverse market-to-political policies influence through lobbying; campaign contributions to particular party candidates justify these circular relationship to firm-specific stock price effects (Knight, 2007; Siokis and Kapopoulos, 2007; Mattozzi, 2008; Brunner, 2009; Wong and McAleer, 2009; Gerber, Huber and Washington, 2009; and Furio and Pardo, 2010). Therefore, the political outcome of an election affects corporate performance as a result of the pattern of government expenditure, tax policies, consumption patterns and investment. Inflation-unemployment interplay as well as other key macroeconomic parameters are at the mercy of the ruling class possibly due to the fusion of monetary and fiscal agencies. Accordingly, Oehler, Walker and Wendt, (2011) avow that through sector-specific governmental decisions, stock market information integrates into stock prices prior to an election window. They conclude that party’s ideology impact statistical significance using the cumulative abnormal returns. This implies that presidents and their political parties’ ideology are instrumental to national economic health. Where economic fundamentals are at variance with realities, the traditional political economy models determine market operation. Empirical evidence in support of no significant impact of partisanship on inflation stems from the evolution of a single European currency as national monetary policy. Here the regional regulatory agency’s (European central bank) objective of sustainable price stability comes to the fore (Lijphart 1999; He, Lin, Wu & Dufrene, (2009). This reduces the probability of volatility decrease as winner of the election becomes clearer (Goodell & Bodey, 2012). Historical interdependences between politics and economy is undoubtedly a statement of fact using general elections as a political economic tool. The existence of short-term election bullrun and long-term election cycle effects coupled with political party induced-market returns lend further credence to the issue under discussion. This is substantiated by election cycle pattern as


evidenced in Nigeria, Taiwan and the U.S though differences in pattern with worst returns occurring in a post-election year. These variations are not unconnected with deepened democratic and political culture, strong institutions as well as robust market economy. This is consistent with political business cycle theoretical postulations. The absence of election bull-run in Taiwanese presidential election without the legislative election coupled with incumbent party advantage appear to justify the aforementioned (Liu, 2007; Hung, 2011; Graefe & Armstrong, 2013). Hsu and Yu 2005; Catania, 2010; Newman, 2012; Opare, 2012; Eriki and Eboigbe, 2012) profess bullrun after election which is short-lived using general election (presidential and legislative). Interestingly, Chretien and Coggins, (2015) opine that the level of development of a country democracy and Stock market determine their response to political economic information and better opportunities. Researchers attribute capital market reaction to political economic information and investors apprehension of the indeterminate and unpredictable nature of elections either due to policy summersault and reversal or market reactions and sentiments (Nicholas, 2004; Angela and Ngugi, 2007; Wing-Keun and McAleer, 2007; Wang, Mei-Yu and Che-Yang, 2008; Valadez and Nickles, 2009; Ro, 2012; Kumar and Jucunda, 2015). Connecting the theoretical linkage between parties’ preferred economic policies and macroeconomic








Wellershoff,1995;Foerster and Schmitz 1997; Drazen,2002; Leblang and Mukherjee 2005; Juan, 2011) posit that there exist statistically significant effects of government partisanship on stock market performance; national economic performances arises policies objective and economic interests coupled with subjective preferences of their political constituencies. In contrast (Doepkea & Pierdziochb, 2004; Powell, Shi, Smith & Whaley, 2007; Fuss & Bechtel, 2008; Jones & Banning, 2009; Abidin, Old & Martin, 2010; Sy & Al Zaman, 2011; Furio & Pardo, 2012; and


Sayce, 2013), show no significant impact hence, refute stock market returns tendency to reveal partisanship and political business cycle effect.

They affirm a unique implications with

possibilities for further research. Arising from these divergences and timing difference in the political business cycle theory, this study seeks to validate the concept of political business cycle theory and its policy implication using some selected economies. This is done by determining the extent to which political activities impact on national economic performances, stock market returns (abnormalities) as well as selected industry/firm stock returns in a frontier nation. 1.3 Research Questions The following questions has assisted in the study. To what extent does interest rate, inflation and output gap significantly vary within electoral cycles? How does capital market volatility relate to changes in exchange rate within electoral cycles? To what extent does national economic performance indices depend on electoral cycles? How does partisanship/governance style and market returns depend on political events within electoral cycles? To what extent does incumbent government political ideology impact on nation’s capital markets prices? What is the relationship between information uncertainty driven by political events and stock market prices or returns in Nigeria?


Finally, to what extent does political connectivity of firms’ owners’, industry and market returns interrelate? 1.4 Objective of the Study. The general objective of the study is to examine the interdependence between political events and some economic indicators. The specific objectives are as follows: 1 To examine the reaction of inflation rate, interest rate and index of industrial output in electoral cycles; 2 To examine the relationship between stock market volatility and changes in exchange rate within the electoral cycles; 3 The study is also to examine the relationship between national economic performance indicators and electoral cycles; 4 To also ascertain the relationship between partisanship/governance style and capital market returns; 5 The study is also to ascertain the existence of opportunistic political business cycles effect on nation’s capital markets; and 6

To ascertain the existence of Uncertainty Information Hypothesis using Nigerian capital market and presidential election postponement; and

7 To determine the relationship between electoral events and specific/industry stock market returns.


1.5 Statement of Hypotheses. The following hypotheses were tested 1 There is a significant positive difference in rate of inflation, interest rate and index of industrial output within electoral cycle; 2 There is a significant positive relationship between market volatility and exchange rate within the electoral cycles; 3 There is a significant positive relationship between national economic performance indices and electoral cycles; 4 There is no significant positive relationship between partisanship/governance style and market returns; 5 There is a significant positive opportunistic political business cycles effect in national capital markets; and 6

There is a significant positive Uncertainty Information Hypothesis in Nigerian stock market prices using presidential election postponement; and

7 There is a significant positive relationship between electoral events and firms/industry stock returns in Nigerian capital market. 1.6 Scope of the Study The study considers the relationship existing between political events and some national economic parameters for various countries. These countries include the United Kingdom, United States of America and Japan (representing Organization of Economic Cooperation and Development-OECD), China and Hong Kong (representing Far Eastern nations) as well as Egypt (representing Arabian market). Also on the list of nations are Republic of South Africa and Brazil 27

(representing Members of BRICS nations), Germany and France (representing European Union markets) and Nigeria and Kenya (representing African frontier market).This is with a view to demonstrating that the relationship between capital market performances and various national economic indices relationship with national political events is a global issue. On the time horizon, the research covers 1999-2016 electoral development, key national economic indicators and capital markets activity. The period is chosen as it coincides with global financial meltdown and competitive global business of the 21st century. Macroeconomic variables relevant for measuring national health such as inflation, exchange rate, unemployment and the index of industrial output/productivity were used in the study. This is because they are the barometer for national economic measurement. Also on the list are interest rates and stock market prices. A look at the list reveals that the countries have stable democratic culture as well as leaders in their respective economic and sub-regional groupings. The sampled countries are in the first forty largest economy hence their use so as to substantiate some globally acceptable economic and investment decision theories. Availability of dependable and credible data by recognized global agencies further justify our choice of the countries. 1.7 Relevance of the Study. Since Nordhaus (1975) confrontational prophecy of opportunistic administrations’ capability to create economic variabilities and rotations within various cycles, efforts to authenticate it using ex-post information from different countries have been on the increase. This research undeniably backs up some existing literature in a number of ways. Firstly, it seems that partisanship of political revelries and style of ascendency to power in global political event windows have not been documented as behavioural finance theory. Therefore, this research is substantially a revolutionary study. More importantly, specific firms or industry relationship with 28

business environment seems to be been determined by the IECs (Industry, Economic and Company) fundamentals alone without considering the effect of political party ideology fussing with behavioural finance theories. The result of this study enables relevant agencies to predict the direction of the economy before and after the electoral processes. Changes in stakeholders’ sentiment driven by return variability around electoral events dates is also predicated on stock markets return and political uncertainty (Stein & Streb, 2004; Stein, Streb & Ghezzi, 2005). Cross-border investors will find succour from the outcome of the study in the ascertainment of a country’s specific political risk and favourable investment timing. The outcome of the study will also wake up the consciousness of electorates whose memory is assumed to wane shortly after electoral events by political actors (Nordhaus, 1975). 1.8 Limitation of the Study A number of problems tends to limit the precision of the result of the study. In consideration of the various geography of the selected countries, the problem of heterogeneity and simultaneity that may exist between policy instruments over time has the tendency to distort the result. Using the panel Generalized Method of Moment methodology, these challenges were reduced. Secondly, data availability for the countries were pooled from different sources with some based on assumptions and estimations without precision. Possible errors from theses background might likely affect the overall result of the analyses. This though makes the results to be satisfactory within a range not with exactitude. This also necessitated the time horizon component of the study scope which limits the study to 1999-2015 and the countries to thirteen (13) when the study should have cover one hundred and ninety-two countries (192).


CHAPTER TWO LITERATURE REVIEW 2.1 Introduction This part of the study dwells on the theoretical, conceptual and empirical postulations of political events and economic fundamentals as they relate to the general performances of countries.

2.2 Theoretical Review Here a review of various circles in the economic performances of nations and capital markets activities is considered necessary. 2.2.1 Political monetary cycles Theory (PMCT) Political actors’ willingness to show their competence and capabilities to the electing populace manifest as they try to prevent high inflation and high interest rates in the months prior to an election. Evidence of such signs also appears in currency devaluation postponement till postelection days. This is one of the building blocks of opportunistic political business cycles theory. Where politicians deliberately alter economic strategies to promote short-run growth with a view to attracting votes during an election, it is of essence therefore to align reaction functions with the causal events. This justifies the creation of an autonomous monetary authority. This authorities has the capacity to issue guidelines and public-oriented policies such as monetary policy to insulate the aggregate economy from partisanship and administrative pressure in the form of fiscal policy. In some countries, the political business cycle theory of monetary policies significant reaction to election anxieties have being proven (Heckelman & Wood, 2015).


2.2.2. Political Business Cycles Theory (PBCT) Political business cycle theory assumes that the aggregate economy swings as power changes between leaders of different political parties (Blomberg & Hess, 2003). It is an undeniable fact that electorates and other economic agents are favourably disposed to low employment rates and inflation. Politicians’ awareness of these indicators coupled with their belief that voters have decaying memory of past events necessitate their attempt to make electorate happy as election draws near. Like Nigeria and many other developing countries where the bulk of voters are more of the low income class, the knowledge of their preferences makes the political actors to structure their electoral promises. This is the bedrock of political business cycle theory. Nordhaus (1975), posits that closely after an electoral window, administration increases job loss with so many economic contractionary fiscal and monetary policies to a comparatively high level so as to check inflationary trend occasioned by excessive political spending. As their administration get closer to yet another elections, unemployment rate tends to decrease by some expansionary fiscal and monetary policies which are temporary. Unquestionably therefore, political business cycle theory examines the bond between governmental cycles and economic cycles with reference to how election timing effect, political ideological orientation, and the nature of political culture among contending parties impact on the general economy. Unemployment, economic growth, rate of inflation and a number of monetary and fiscal policy instruments therefore appear to be a reflection of politicians’ ideological orientation (Jula & Jula, 2008, Jula, 2010). PBCT means the management of national macroeconomic policy by office holders so as to stimulate the aggregate economy with a view to aiding their re-election. Incumbents’ votes undoubtedly increase during the period of growth and decline during periods with high unemployment and inflation. 31

Opportunistic opposition governments certainly elect to fortify strategies that are against inflation with a view to wining the voter sympathy in the course of election years. At the same time incumbents, who implemented contrary policy of reducing inflation, might increase the monetary expansion towards the end of their electoral mandate. This is done so as to meet elections in a period of aggregate economic growth (Schultz, 2003). The more competitive elections are, the higher the tendency to create PBC where opportunistic strategy stimulates economic expansion by sustaining avoidable cost for social welfare (Krause, 2005). The two predominant theories of the PBC are opportunistic and partisanship business cycles. 2.2.3 Opportunistic Political business cycles Theory (OPBCT)

Variability of economic activity (financial markets, monetary and fiscal) originating from external interference of politically aware actors seeking to be re-elected is termed opportunistic business theory in the cycles of politics. PBC is premised on quite a lot of assumptions. Amongst which is that there exists a short-term trade-off between the level of manpower and resources utilization, employment and inflation in the aggregate economy. There is the presumption that political officeholders are rational actors in ranking their political objectives. Therefore trading off inflation for lower levels of unemployment in any run-up to elections is a deliberate pursuit, hence a subject of concern to financial economist and researchers.

2.2.4 Partisanship Political business cycles Theory (PPBCT) Partisan theories highlight the alteration in fiscal and monetary policies that exist between political parties and the general economic indices within the presidential cycle or duration in office. Where the opposition government anticipate boosting of the aggregate real economic activity using full


employment as a critical factor, the incumbent government focuses on aggressive inflation. Each of these goals has multiplier effect on the wellness of the citizenry. 2.2.5 Reverse electoral business cycles Theory (REBCT) According to Canes-Wrone and Park (2010), political uncertainty engendered by electoral event buoys up private investors to delay their investments. This they say is not unconnected with high costs of reversal resulting in pre-election deterioration in aggregate economic activity. Hence they call it reverse electoral business cycle. The motivation for investment delay is a function of the size of policy differences between the contending political parties. This increases the prospect of postponing certain investment activities and purchases which affects corporate earnings and the nation’s gross domestic product (GDP). 2.2.6 Real business cycle Theory (RBCT)

Business cycles are better explained by the traditional Real Business Cycle theory (RBCT). The theory is dependent on three conventions. Firstly, it is driven by enormous and rapid changes in productive strength. Secondly, unemployment reveals changes in pay employees are willing to accept for a specific job and thirdly, the independence of monetary policy with economic performances. RBCT sees economic cycles as resulting from frictionless and competitive economies in the context of real shocks. The frictionless financial market denotes transparency where asymmetric information that drives adverse selection and moral hazard is absent. From this analysis, RBC theory therefore sees business cycles as real reflection of the most efficient operation of the economy and not market failure. This is consistent with competitive overall market equilibrium were economic agents are rational. Nelson and Plosser, (1982) find the proposition that GDP growth tracks a random walk and cannot be regarded. RBC models aver that firms and households have unambiguous goals, they maximize their utilities subject to budgetary and 33

manufacturing restrictions. Business cycles are generated by exogenous productivity distortions or shocks enlarged by fundamental factors like substitution of factors of production, changes in the supply of labour, consumption smoothing, and investment delay. Though real business cycles occurrence are not instantaneous but take some period of time and affect dissimilar industries at the same time. This is called market efficient response to external alterations in general economic setting.

Furthermore, as people and corporations have trade-offs like consumption-investment choice as well as labour-leisure trade-off, the aggregate economy using RBC model foresees that during temporary shock: productivity, consumption, investment and employment will increase above their respective long-term trends. Therefore business cycles rising and falling are products of accumulation or de-accumulation of wealth, which are determined by the prevailing national politico-economic culture (Blomberg & Hess, 2003). These models integrate many factors upon which economic variations hinge, but fail to take cognisance of office-bearers influence in the cycles powered by their quest for re-election. As individual have preferences so also do governments. Such preferences may not be consistent with the need of the economy at that point. Therefore, politicians and their parties cannot be trusted with proper and public oriented macroeconomic policies. This is because of politicians’ determination to adjust the institutional capacity of existing economic policy structures with a view to realizing their short term aim of winning elections.

In the light of the above, independent central banks with constitutional mandate to provide a definite and realistic inflation target that will undo the political manoeuvrings of office holders. Evidently, developed economies tend to increase monetary regulating agencies’ independence by


depoliticizing monetary policy framework. Expansionary monetary policy by the regulatory agency couple with fiscal framework and politically-induced manoeuvrings signals serious exposure of key macroeconomic indicators to external and internal shocks. The consequences of these in the short run, result in unsustainable employment position. This impedes economic growth. Some of the hostile trade balances in the long-run promote high inflation rate and exchange rate. These trends in elections cycle sometimes yield cyclical oscillation in national economic activity due to the interplay of deliberate and unnecessary government incentive and restriction. Reversals manifest in the cutting of public expenditures, reduction of money supply and unjustifiable rise in interest rates. This is done so as to correct the artificial prosperity driven by electoral manipulation. These political distortions of the equilibrium rate of employment, inflation and interest rates, trade balances as well as productivity are corrected through the restoration of previously collapsed restraints and incentives.

2.2.7 Uncertain Information Hypothesis Theory (UIHT) Uncertain Information Hypothesis (UIH) holds that investors set stock prices below their market values prior to events taking place with a view to hedging against the uncertainty emanating from it. Uncertainty information hypothesis postulates the likelihood of stock prices overreacting to bad news and underreacting to goods news which discount investors’ expectation of their future earnings. Against these dark spots, this study therefore intends to unravel the rationality, risk-return tangles and information effect in the determination of investment behaviour using the cockroach theory effect. This theory posit that when a company reveals one bad news to the public it is symptomatic of many more connected hidden undesirables. It is derived from the belief that sighting one cockroach is evidence of many more hidden. This is demonstrated in the preferment of a specific political aspirant or political agenda. Therefore, candidate’s programme will directly 35

influence the electoral uncertainty hypothesis (EUH) and political uncertainty hypothesis (PUH). EUH foresees undesirable inverse relationship between stock market volatility and electoral uncertainty of the winner in the short run coordinated by prevailing macroeconomic variables (Graham, Nikkinen & Sahlstrom 2003). PUH posit that election winners’ related information reflects evidence of yet to come macroeconomic policy. This shares some of the ideological belief of partisanship political business cycle. Asserting that party-political uncertainty. This stimulates macroeconomic uncertainty positively inclusive of stock market volatility (Krause, 2005; Malley, Philippopoulos & Woitek, 2007; Diebold & Yilmaz 2009; Arnold & Vrugt 2010). Economic prosperity on the eve of election driven by political players to win an election suggests voters decomposing memory. 2.3 EMPERICAL REVIEW

2.3.1 Political Business Cycles and Monetary Policy Political business cycles (PBC) sometimes called Election Year’s Economics (EYE) refers to politicians and the effect of their actions on the economic parameters and performances in relation to the economic health of sovereign states their capital market inclusive. Presidential Election Cycle Theory postulates weak market in the first-half of an administration and a stronger market in the second-half. This is indicative of serious weapon for stabilizing the markets in the short term for an audience desirous of economic reassurance. It could also be interpreted as where stock market returns are significantly higher in the last two (2) years than in the first two (2) years of the presidential term. Political business cycles (PBC) pioneered by Nordhaus (1975) after the ground-breaking work of Kalecki (1943), has different theoretical perspectives referred to as models.


According to Nordhaus, (1989) political business cycle evaluates the interface of political and economic systems from the viewpoint of voters whose interest is on the economy in contrast to politicians’ quest for power. Interestingly, several models have been postulated by authorities. These include opportunistic political business cycles model, partisanship political business cycle model as well as rational choice theory. The opportunistic model denotes induced expansionary economic activity driven by incumbent government in the period heralding election with the sole aim of enhancing their re-election. It means that policy-makers systematically and deliberately aim for a rise in stock prices in the period preceding elections (Nordhaus, 1975; Lindbeck, 1976; Pettersson-Lidbom, 2001; Chen and Siems, 2005; Bohl and Gottschalk, 2006; Dopke and Pierdzioch, 2006; Mehdian, Nas and Perry, 2008; He et al. 2009; Imai and Shelton, 2011; Aidt et al. 2011; Fiva and Natvik, 2013, and Tanaka, 2015). These activities could result from the intelligent manoeuvring of the political economic landscape using unhealthy fiscal and monetary policy. This is particularly where the economy is subject to the dictates of the government in power. Opportunistic model according to others manifest in an inverted U-shaped relationship (Alt and Rose, 2009; Efthyvoulou, 2012; and Hanusch and Magleby, 2014), in consonance with Eriki and Eboigbe, (2012).This denotes bearish post-election market and bullish pre-elections market. Parties with painful fiscal adjustments reduce current public spending as contractionary policy and increase government consumption excluding security and defence votes. This therefore reveals that opportunistic effect on market returns is of no effect statistically (Alesina & Sachs, 1998; Brender, 2003; Veiga & Veiga, 2007; Brender & Drazen, 2008; Schneider, 2010; Drazen & Eslava, 2010; Buti, Turrini, Van den Noord & Biroli, 2010; Enkelmann & Leibrecht, 2013; and Berlemann, Enkelmann & Kuhlenkasper, 2014). The other model-partisan political business


cycles define fluctuations in electoral cycles as a result of differences in political ideology, goal as well as policy objectives of the leaders (Hibbs, 1977; Alesina, 1987; Conley 2001; Fowler 2005; Fowler & Smirnov, 2005; Powell, Shi, Smith & Whaley, 2007; Powell, Shi, Smith & Whaley, 2009). In a developed democracy, incumbent candidates for re-election ought not to control monetary policy where the independence of central banks and other public interest institutions exist. Evidences abound of executive pressure on the apex monetary authority where her independence does not exist, hence the incumbent political leaders manipulates key macroeconomic variables like inflation, interest rate and exchange rates and unemployment during elections (Hibbs, 1977; Woolley, 1984). Government partisanship, opportunistic and stock market performance are not unconnected with investors’ reactionary response to macroeconomic interplays where fiscal and monetary policies are divergent. Political monetary cycle proxied by monetary policy cycle which peaks before and dips after elections seeks to lend credence to abnormal returns earned over event windows. Researchers have asked if collaboration or independence exist between the monetary regulator and the political machineries. If the answer is in the affirmative, it reflects political partisanship of regulatory agencies. Where monetary indicators dampens as fiscal policy remain constant indicates that monetary regulators submissively accommodate fiscally induced political monetary cycles irrespective of the fundamentals. This development occurs where the political leaders and apex monetary agency compromise its stance as postulated by the opportunistic theory of presidential business cycle. Therefore, expansionary monetary policy prior to presidential elections implies that monetary regulation is dependent on political manipulation (Abrams & Iossifov, 2006; Abrams & Butkiewicz, 2012; Funashima, 2013; Jones & Snyder, 2014). This is further confirmed by electoral


period contractionary budgetary policy resulting in significant increase in unemployment rate in the first half of the tenure (post-election year). The complementary expansion at pre-election years tends to lower unemployment rate (Nordhaus, 1975; Haynes & Stone, 1990; Coelho, Zeiga & Veiga, 2006). According to Sieg and Batool (2012), GDP growth and public sector investment declines at pre and increases at post-election window, perhaps owing to inefficiency in resource allocation. These assertions are consistent with the postulations of electoral business cycle theory where politicians use expansionary economic policies to entice electorates in a pre-election period for reelection. This they do as electorates prefer high growth, reduced unemployment and single-digit inflation rate. Therefore, the use of expansionary fiscal and monetary policies to create a shortterm economic prosperity during election period is a veritable tool for the political class. These key national economic performance indicators reverse almost immediately after the political events. The contractionary monetary and expansionary fiscal policies result in what we call political monetary cycles and political budget cycles in election years. Brender and Drazen (2005, 2008), Taeko (2009) trace political budget cycles to newly and younger democracies than established democracies as developed democratic culture and her voters are well informed about the political manipulation of economic policies by violating central bank statutory functions. Taeko (2009) reveals the existence of election-induced monetary cycles with floating exchange rates and fiscal cycles with fixed and crawling peg exchange rate regimes in Brazil. He submits therefore that political monetary cycles are predominantly encouraged by opportunistic politicians when the authority of the central banks shares party affiliations and are less independent in their monetary operations.


2.3.2 Political Business Cycles, Gross Domestic Products and Stock Market Price According to Chittenden, Johnson and Jensen, (1999), Santa-Clara and Valkanov, (2003) and Booth and Booth, (2003), US Treasury bonds and bills produce higher returns under Republican presidencies with a corresponding higher equity returns under Democratic presidencies in the second half of a presidential term. This therefore lends credence to both events-related effects over specific window and presidential business cycle theory. Using estimates of expected return and standard deviation criterion, Foerster, (1994), Normandin, (2004); Chretien and Coggins, (2009) allude to the existence of prime ministerial cycle effect and presidential business cycle effect from the neighbouring nation of the US on the Democratic equity premium of Canadian stocks, but negligible liberal equity premium effects on investment opportunities. They further posit that returns on investment are significantly better in the late parts of the federal election cycle than in the first two years. This, some analyst believe is the effect of high political uncertainty in the business environment occasioned by loss of confidence and inconsistent policies of the preelection period. From the result, investors would gain immeasurably by aligning with electoral regime signals that will optimally result in large asset allocation shifts. Traditionally, stock market volatility ought to be fully explained by predictions of different present value models, various macroeconomic variables, financial leverages and trading volume in terms of market breadth and depth. From the subject of discussion therefore, it means there are many other factors that impinge on the functioning of stock market and financial sector performances. Such factors as general economic activities, exchange rates, interest rates, loans and debts, policies and regulatory pronouncements should be integrated into the stock markets studies. Factors like mergers and acquisitions, politics, global terrorism, stock market integration of several countries and contagious neighbourhood effect thus affect stock market efficiency and financial 40

sector performances. (Heaney & Hooper, 2001; Aisen & Veiga, 2005; Jensen & Schmith, 2005; Clark, Masood & Tunaro, 2008; Aisen & Veiga, 2010; Senyuz, 2011; Damico & Farka; 2011; Ikizlerli & Ulku, 2012; Cao, 2012; Gul, Khan, Saif, Rehman & Roohullah, 2013; Zafar, 2013; and Contractor, 2014). Only a negligible proportion of the variations in the market volatility were captured by the industry, company specifics and economic fundamentals of business. Hence, evidences abound that political uncertainty in particular, influence market returns, risk levels of financial assets and the general economic performances of the nation. Amongst several electoral events, presidential elections appear to exact greater influence on these variables. This is perhaps due to political announcements such as promulgation of various regulatory standards, referendums, law amendments, implementation of one-off policies with the attendant effect on the general economy (Shiller, 1981; Schwert, 1989; Gemmill, 1992; Bialkowski, 2008; Pantzalis, Stangeland & Turtle, 2000; Hsu & Yu, 2005). Electoral events apparently seem to affect economic performance with incumbents displaying their partisan ideological orientation within the mandate cycles. The ability of incumbent presidents to enhance their ratings and grip by manipulating monetary and fiscal tools align with the assumption of political business cycle. Aid also plays pivotal role on opportunistic PBC through donors guaranteeing support to governments in power, which inadvertently drives macroeconomic stimuli inconsistent with appropriate policy needs of the economy. This unhealthy support thrives on political strategic considerations and selfish economic relationship between donors and recipients (Alesina & Dollar, 2000; Block, 2002; Barro and Lee, 2005; Rajan & Subramanian, 2005; Dreher, Sturm & Vreeland, 2009; Doucouliagos & Paldam, 2011; Faye & Niehaus, 2012; Mosley & Chiripanhura, 2012; Shepherd & Bishop, 2013; Chiripanhura & Ninozarazua, 2015; Baulch & Le, 2015). Celasun and Walliser (2008), Briggs (2012), Jablonski (2014) 41

and Dietrich and Wright (2014) affirm that unpredictability of aid flows encourage its ineffectiveness as its volatility is disruptive to economic management. They assert that changes in aid and spatial distribution of multilateral donor projects in a period before election confer on incumbent advantages over their challengers. Treisman and Gimpelson, (2001) frown at the pressure for enhanced governance, democratic culture and structure as well as institutional reform as a precondition for aid and international financial support. This further demonstrates why minority parties are more embarrass by electoral-related aid. With this, majority parties are better endowed to pursue partisan objectives using macroeconomic policies instead of general economic development (Golden & Poterba, 1980; Haynes & Stone, 1990). Empirical results of PBC theory suggest that macroeconomic indicators (GDP, investment, inflation, exchange rate, and interest rate) adjust prior to the elections in an election year and in the period after the elections. Imai and Shelton, (2011); Koksal and Caliskan, (2012); Koksal and Caliskan, (2012); Alvarez-Ramirez, Rodriguez and Espinosa-Paridas, (2012); and Belo, Gala and Li (2013) reveal the absence of political business cycle theory, rational partisan theory and partisan theory. They assert further that the only presence of partisan effect is on volatility and not on the returns. This also agrees with the findings of these researchers (Landler, 2000; Bradsher, 2008; Poon, 2012; Poon, Mozur, Hsu & Liu, 2012; Culpan, Sung & Forsythe, 2012) that when electionrelated events are announce, the stock market faces a slowdown and even a drop as uncertainty arises. This to the study is the event effect, neither opportunistic nor partisanship but aligning with what Canes-wrone & Jee-kwang, 2012, Julio & Yook, 2012, Canes-Work & Park 2014 call reverse electoral business cycles. Cycles resulting from policy uncertainty induce investors’ postponement of investments and consumptions. This has a directional impact on aggregate demand and supply. Stock prices 42

are determined by market forces represented by the depth and breadth of the market. They argue that reverse electoral investment cycles is stronger in countries with weak institutions, less consolidated democracies, low political and economic development, hence higher political uncertainty tends to result in higher volatility of stock prices and other key national economic performance indicators (Brender & Drazen, 2005; Alt & Lassen, 2006; Shi & Svensson, 2006; Lupu & Riedl, 2012). Koksal and Çalışkan, (2012) say PBC hypothesis is not supported by their data but found permanent partisan effects reflected in the conditional variance but not in returns. They affirm further that the conditional volatility of the returns is party-induced thereby providing better evidence of rational partisan theory. Increasingly, political scientists, financial analysts as well as economists are beginning to x-ray the interplay between political-economic indices and stock markets. Arguably, globalization and regional economic integration induce political parties’ policies through partisan effects on financial markets, monetary and fiscal policy manipulation. The independence of European Central Bank (ECB) from the political processes of Europe’s coupled with European robust market, strong institutions and the various components of semi-strong forms of efficient market assumptions are seen as mitigating factors of market sentiment of stakeholders (Fama, 1970; Drazen, 2002; Hays, Freeman & Nesseth. 2003; Mcgillivray, 2004; Alt & Lassen, 2006; Alpanda & Honig, 2009; Taeko, 2009). If markets process information efficiently, effects of different parties holding office anticipated in the near future should be incorporated into current prices. The rational choice theory postulates that a market is efficient in incorporating all relevant information into stock prices, thereby eliminating market disequilibrium. Information asymmetry and the associated moral hazards occasioned by information advantage that investors are exposed to are also eradicated. As efficient stock markets react to news, the tendency for an investor to outperform the market at the expense of others is 43

negligible. News of future events like emerging economic policies, political events such as Brexit, general elections, dissolution, coup d’états, riots, democratic transitions, to mention but a few have the propensity to alter nation economic architecture (Wolfers and Zitzewitz, 2004; Suleman, 2012). Information from these aforementioned seek to confer profit maximization advantage on the rational, speculative and informed investor. Political uncertainty fuels heterogeneous expectations amongst market stakeholders. With strong monetary institutions and political transparency, stock price volatility is mitigated (Henry 2000; Hays et al 2003; Chae, 2005; Alt and Lassen 2006; Miya, 2007; Ciner and Karagozoglu 2008; Alfaro, Kalemli-Ozcan and Volosovych, 2008; Rodríguez and Santiso, 2008). Boutchkova et al. (2007), affirm that volatility of stock markets is directly related to a weak system of political governance as volatility is greater in sector dominated by state-owned firms. Bohl and Gottschalk (2005), Pierdzioch and Dopke (2004), Fuss and Bechtel, (2008) reject the conjecture of partisanship in stock markets. Aleh (2013) shows the influence of information transparency on stock returns and volatility on reduction in investment and real output (a vital component of gross domestic products). They argue that corporate earnings reports, macroeconomic indicators, political statements and news affect returns volatility. This they further aver is fuelled by alterations in information transparency, particularly at periods proximate to the event of study. The role of exchange rates, capital mobility and independence of central banks in defining political cycle interaction with the economic cycles, further reinforced the position of the behavioural financial analyst. Their position is that fundamental theories and traditional models alone cannot be used in the determination of financial assets pricing. Besides, Capital Assets Pricing Model (CAPM), Arbitrage Pricing Theory (APT) and other models proved to be insufficient. Thus, monetary, fiscal and macroeconomic policy-mix decisions affect volatility and stock market returns. Consequently, that economic parameters 44

influence voting behaviour substantiate the proposition that the interactions between stock markets, public policies, political uncertainty in financial markets and national economic performances are inextricably linked is a statement of fact (Hallenberg & Souza, 2000; Lynch 2002; Grier, 2008; Fair 2009; Vahamaa & Aijo 2011). 2.3.3 Election Cycle and Exchange Rate Movement The failure of the dollar standard of the Bretton Woods of 1944 led to the change of exchange rate system from fixed regime to floating regime. In managed float regime, individual states are at liberty to intervene in the management of their foreign exchange rates through the instrumentality of the monetary policies whenever they deem appropriate. This politico-economic freedom confronts governments with trade-off between gains in economic efficiency and monetary policy credibility. On the other hand, it leads to loss of monetary policy autonomy to political manipulation. There is therefore a consensus that the quality of the political system and its institutions are fundamental to a country’s prosperity. Kang, Wang and Yoon (2002), Frankel, Schmukler and Serven (2002) show that the adoption of free floating exchange rate will not insulate an economy from external currency and exchange rate volatility shocks. These shocks are evidenced in export-import relationships that lead to trade balance figures between trading nations. Though it reduces the interdependence entrenched in the monetary independence of the various regulators at national economy level. Economic disorderliness such as a shift in global demand resulting from political economic interactions of expansionary and contractionary monetary policies will be at the mercy of trading partners’ absorptive capacities. This therefore play vital roles at restoring the equilibrium position of the nation through stimulated demand for domestic products and the return of the economy to desired levels of employment and output. International openness in the form of trade and capital 45

flows promote business cycle harmonization across countries without recourse to the political structure. This harmony is enhanced by the interplays of trade and capital markets among countries nurtured by foreign portfolio investments as well as global or regional economic blocs’ common shocks. Therefore, it is a truism to say that the co-movements of the business cycles and electoral cycles fostered by the transmission of country-specific shocks to other countries reveal the absence of absolute independence of national monetary regulatory agencies and the government in power. This further reinforces the chances of the opportunistic and partisanship effect on the capital market development and the various cycles within the economy (Levy-Yeyati and Ubide, 2000; Loayza, Lopez and Ubide, 2001; Kawai and Takagi, 2001). Symbolically, trade integration thus lead to business cycle synchronization amongst trading partners. Hence, a high financial asset price correlation could lead to increasing real economic activities across countries Dalsgaard, Elmeskov and Park (2002). Researchers have alluded to the fact that local currency devaluation is one of the monetary policy tools most unlikely to be implemented in the pre-electoral period but proximately post-electoral period issues for an incumbent administration. Therefore, investors’ knowledge of these regulatory monetary romance with politics and such other expectations of post-election devaluations will certainly induce pre-election declines in investment which will result in economic infractions (Rogoff, 1990; Frieden, Gezzi, and Stein 2001; Leblang 2003; Stein and Streb 2004). Stein and Streb, (2004), Stein et al. (2005) submit that electoral events in Italy increase short-term interest rates, reduce equity returns and run down her current exchange rate significantly. This they aver further leads to structural disruption in the macroeconomic variables before the emergence of European Central Bank (ECB). The ECB therefore helps in the insulation of the general economy by the severance of monetary units from domestic regulators.


Time inconsistency considerations of political business cycle acknowledge that policy makers benefit from monetary stability in the long-run consequent upon its ability to resist the short-run incentives instability Bernhard et al. (2002). Also worthy of note is that the choice of a stable and growth enhancing exchange rate regime depends on the desire to fight inflation rather than political consideration, institutional strength as well as partisanship preferences of the key players (Bernhard and Leblang 1999; Clark 2002; Keefer and Stasavage 2002; Hallerberg 2002; Clark and Hallerberg 2002). Time inconsistency arises from the conflicts between long-term and short-term target. Exchange rates and money supply components of the monetary policies ought to be predictable and credible for sustained economic growth and development. Where politicians and deposit money bankers with little or no knowledge of these policies now determine when and how to peg; the national economy suffers hence Central Banks independence is sacrosanct. This is consistent with Stasavage, 2003; Shambaugh, 2004; Genberg, & Swoboda, 2005; Von Hagen, & Zhou, (2005). This monetary transmission mechanism resulting from the acceptance of devaluation risk on nominal interest rate and money supply in an open economy with an open capital account due to events that are time-bound and exogenous to economic developments. According to Fratzscher and Stracca, (2009), Lim, (2003), Stein, Streb and Ghezzi, (2005) and Cermeno, Grier and Grier, (2010), events of essence include political elections, inauguration of new administration, resignations, politically-related suicides, referenda, and politically-inspired terrorism. They aver that post-election exchange rates are significantly less predictable and less volatile and that they disappear shortly after the events. Nevertheless, these aforementioned assertions did not go unopposed as (Frieden et al, 2001; Stein and Streb 2004; Stein et al, 2005) find no trace of electioninduced appreciation in their test for political budget cycle in nominal exchange rates


2.3.4 Stock Market Prices, Uncertain Information Hypothesis and Market Efficiency Brown, Harlow and Tinic (1988 & 1993) revolutionary work of Uncertain Information Hypothesis (UIH) with a follow-up of (Vuchelen, 2003 and Razvanian, et al 2011) assume that investors set stock prices below their fundamental values determined by economic, industry and company’s specific factors prior to an event taking place with a view to hedging against uncertainty emanating from it. Uncertainty information hypothesis postulates the likelihood of stock prices overreacting to bad news and underreacting to good news by discounting investors’ expected future earnings. This volatility signalling the unpredictability in stock returns surges following the arrival of unexpected information is a key component of efficiency market hypothesis (EMH).

By rule of the thumb, a rising trend in such prices follow as events become more certain. Where election-induced uncertainty reduces, risk-adjusted expected return falls with stock prices rising (Lee, 2004; Ngu, 2004; Yusof, 2004; Moten, 2009). But the reverse was the case when the announcement of the 2013 general election results in Malaysia led to a remarkable hike rather than an expected price nose-diving in the financial market. This some researchers opine is the result of delay, unstable political environment and the structure of the countries as well as lack of institutional independence (Pantzalis, Strangeland and Turtle, 2000; Nippani and Medlin, 2002; Fehle and Zdorovtsov, 2003; Nippani and Arize, 2005; He et al 2009; Vahamaa and Aijo 2011; Eriki and Eboigbe, 2012). They find positive abnormal returns during the two-week period prior to the elections and therefore recommend that investors and other stakeholders should develop financial skills for interpreting the interplay between political events and the economy. This is to enable them know when to buy, hold and divest their holdings in a highly uncertain economy. Interestingly, some studies conclude that there is lack of evidence of stock market 48

overreaction towards general elections and other electoral events (Li and Born, 2006; Ali, Nassir, Hassan & Abidin, 2010; Akkoc and Ozkan, 2013). Furio, and Pardo, (2012) see stock market performance and volatility around election dates as significantly bearish the last three trading days and statistically bullish on the day following national elections. Li and Born (2006) find stock prices surging before presidential elections with high uncertainty. Interestingly, Goodell and Bodey (2012) reveal a negative relationship with fall in price as a result of election uncertainty around U.S. presidential elections and price-earnings ratios implying that there is an events uncertainty impact.

2.3.5 Election Business Cycles, Unemployment and Inflation Politics and economics appear to be two dependent fields of human existence that cannot be separated as political business cycles reflect. Political business cycles represent unending activities in macroeconomic variables with its origin in electoral activities. The trade-off between inflation and unemployment is assumed to thrive on the myopic and weak retrospective views of voters, hence, opportunistic political business cycle model envisages governments’ willingness to shoot up employment just before elections through various operational policies Garcia-Sanchez, Mordan and Cuadrado-Ballesteros, 2014; Vasquez-Ruiz, Rivas and Daz, 2014). Opportunistic behaviour takes effect in pre-election years, while the partisan behaviour manifest between different parties’ tenure in office (Klomp and de Haan, 2013; Foremny and Riedel, 2014; Shelton, 2014). Therefore, there exist a timing difference in the political business cycle theory. According to Karakas (2014), political business cycles manifest in all countries regardless of stages development, governance structures and robust institutional framework. That political manipulation using electoral outcomes confirm the critical role of macroeconomic variables (real


per capita GNP, inflation, taxes and unemployment) in the exploitation of voters irrationality as evidenced by short memories. The manipulation of policy tools by incumbent politicians through the stimulation of the economy during the period before election to enhance re-election chances could be expansionary or contractionary as reflected by monetary and fiscal policies. Interestingly, such deliberate pursuit might result in unpleasant consequences in the longer-run (e.g. hyperinflation, growth without corresponding development, low rate of savings, unfavourable trade balance, etc.). Reversal of actions such as raising taxes, interest rate getting to its ceiling without recourse to economic fundamentals and market forces, as well as heightened austerity measures make the voter to bite the bullet. Rakic, Stanojevic and Rađenovic, (2015) submit that inflation and unemployment in the pre-election window is determined by political interests with the ultimate reversal in postelection period to initial level before the electoral events. People employed into illegal activities such as prostitution, drug-dealing, illegal gambling operations, smuggling etc. are termed unemployed due to their not being subject to taxes and other rights and privileges as state citizens. Politicians demand for re-election without considering the national economic stability and social security of citizens lend credence to their use of expansionary monetary policy before the elections so as to reduce unemployment (Akhmedov & Zhuravskaya, 2004; Drazen & Elsava, 2005; Veiga & Veiga, 2007; Findley, 2015). These monetary expansionary policies can brings to the fore the relatedness of political business cycles and political budget cycles. They assert further that periods of low unemployment with low inflation rate increase the probability of re-election processes which reverse shortly after as inflation adjusts. Drazen (2000) opines that to cushion the inflation-unemployment puzzle (tradeoff between the inflation rate and unemployment), central banks accommodates this political 50

strategy from governments to avert sharp rise in interest rates at the times of election. The absence of a long-run trade-off with reference to inflation and unemployment thus tend to push the unemployment rate beyond tolerable extent with accelerated inflation. We are of the opinion that the absence of long-run neutrality of inflation and growth in money supply are fundamental to wider acceptance if general equilibrium in the economic systems is to be attained. Therefore, unemployment, inflation, money supply, rate of technical progress in capital market, real interest rates, global oil prices and other macroeconomic shocks have effect on national social and economic welfare. Monetary instruments influence on the behaviour of interest rates is spontaneous with inverse relationship. This agrees with the postulation that monetary regulation is dependent on political manipulations. Central banks independence reduces inflationary bias, hence they cannot be subject to electoral deadlines (Leertouwer & Maier, 2001&2002; Sakurai & Menezes-Filho, 2008). Haynes and Stone (1989) find a four year cycle on GNP, unemployment, GDP, inflation overlapping with elections time. Tutar and Tansel (2000), Kuzu (2001), Asutay’s (2004) study reveal budget deficit relationship with electoral cycles in Turkey with monthly and quarterly data but with annual data, there is no result indicating that election effect vanish in annualized data. The economic implications of these variables impact negatively on unemployment as a result of the shock promoting firms and plants death (Cerda & Vergara, 2007). Capital markets activities as well as general economic development thrive on volume (breadth and depth), confidence and liquidity fuelled by increased cash flows. Liquidity problems in the financial markets accompanied by low productivity tends to reinforce credit constraint shock, with an associated effect of recession which is highly detrimental to the economic health. Inflation-targeting central banks policies seem


to put more emphasis on employment and wage changes so as to prevent surge in wage inflation to forestall general price inflation. The differences in economic conditions of members of various regional political and economic groupings manifest in various countries business cycle dynamics and reactions to monetary policy framed on the basis of national macroeconomic data (Overman & Puga 2002; Wall & Zoega, 2002; Fang & Silos, 2012). Unemployment is both a cost to the workers, employer and the nation in general. The workers purchasing power diminishes without income, employers’ experience low productivity with lower market share and reduced turnover while the national economic performance will experience lower GDP inclusive of dips in capital market indices. The reaction of inflation and output gap driven by increased unemployment at any period have a multiplying negative effect on the general economy. The pre-election period’s political objectives of incumbent parties ought to unite with opposition parties. Low unemployment, high economic growth, and moderate inflation, coupled with market-induced monetary-fiscal policy mix before and after elections guarantee price and exchange rate stability. Increment in public sectors investments, expenditure on employees’ compensation, subsidies, unemployment benefit and social welfare prior to an election window with imminent reversal afterwards show that the players are not interested in the citizens’ wellness rather they are interested in their inordinate ambition. Governments’ deliberate increase in tax revenues before elections to fund increased expenditures and manipulated fiscal policies end in redistributive manoeuvring. These they do by making limited liability businesses and individuals to go through recession. This recession immediately translates into the national health as evidenced in the GDP and other indicators after the events (Kachelein, Imami & Lami, 2008; Holger & Imami, 2009). Wolfers (2002) find that increase in unemployment rate translates to a reduction in the votes received by the incumbent 52

party in an election. Rakic, Stanojevic and Radjenovic, (2015) confirms that inflation and unemployment in a pre and post-election period result from deliberate adjustment due to political interests with the likelihood of return to their original level. This political freedom violating economic freedom leads to biased redistribution of wealth and limits economic liberty. This is usually through the interference of market forces which hamper competition thus culminating in price manipulation. Andrikopoulos, Ioannis and Prodromidis, (2004), Sieg and Batool,(2012) confirm that unemployment tends to be lower in pre-election periods and surges immediately after elections conceivably due to politically inspired employment patterns. They agree further that Inflation drop in pre-election is also not unconnected with pre-electoral price regulatory mechanism and increment in public borrowings to fund deficit budget. 2.3.6 Elections and Specific Firms/Industry Stock Price movement Greenwood and Thesmar, (2011) study the relation between ownership structure, financial assets market prices and non-fundamental risk. They see asset fragility as caused by its vulnerability to shifts in demand driven by non-fundamentals. They affirm that as owners are faced with volatility and liquidity shocks caused by buy or sell, the units of asset ownership experience wide returns variability. This is further explained by the reappearance of high electioneering cost which might lead owners to sell for funding purpose. Consistent with Greenwood and Thesmar (2011) and many other expectations, fragility denotes price volatility not dependent on the fundamental. The dislocating impact of arbitrageurs on stock prices due to arbitrage in the outdated asset pricing theory lends credence to the impact on sales volume and price movement. Traditionally, ownership composition of a financial asset ought not to influence future returns or risk predictability, but where current holders buy or sell for reasons unrelated to fundamentals will not affect the price. Fragility is a function of ownership concentration, volatilities and correlations of 53

holders’ expected liquidity trades. The connectivity between ownership structure and risk therefore buttresses the impact of institutional ownership role on stock price volatility (Johnson & Mitton, 2003; Faccio, 2006; Faccio, Masulis & McConnell, 2006; Jachandran, 2006; Faccio & Parsley, 2007; Goldman, Rocholl & So, 2007; Claessens, Feijen & Laeven, 2008). During partisan political business cycle, companies’ exposure to public spending tend to outperform firms in similar and dissimilar industries with low exposure to public expenditure Santa-Clara and Valkanov (2003). These activities create abnormal excess returns which are usually in the second and third year of an administrations’ term and wanes in electoral years. They assert that this disappearance shows that political linkage pull down profits as employment situated in highly challenged areas increase higher social welfare cost in form of wage bills surge. Their conclusion indicate that political exposures and influence do not only make available benefits but also create costs. Political connectivity of firms confer competitive advantage on firms in the areas of ease of access to finance, funding and tax holidays. It also includes government and other publicinterest contracts as well as soft regulatory advantages that drive performances. Economic manifestation of political exposures of firm’s to government spending affect the capital market volume of trade as well as market returns (Agrawal & Knoeber, 2001; Khwaja & Mian, 2005; Goldman, Rocholl & So, 2008). Politically connected firms tend to adjust their employment and dismissal policies and have higher rates of job and branch network creation before election. They sometimes superfluously maintain low rates of plant and product line deleting. Low profits, higher labour costs and robust labour relation in election years just to help incumbent government in their re-election bid to portray a healthy economy to the ill-informed electorates.


2.3.7 Empirical and Methodological Survey of Some Outstanding Studies Table 2.1: Table of outstanding studies and methodological survey Author Fuss




Bechtel Partisan politics and




Result and Stock returns of small

stock market


1,1 German businesses

performance: the

volatility approach

favoured by

effect of expected

incumbent and at a


disadvantage with

partisanship on stock

opposition winning.

returns in the 2002

Election uncertainty

German federal

leads to reduced



Champagne, Chretien Should investors pay Sharpe ratio similarly Find that recovering and Coggins (2015)

attention to domestic termed the reward-to- stock market and


election variability

ratio prospects move in the

regimes? A Canadian methodology

later period than the


earlier period of the political mandates. It is more for the American Democratic Party as against the


Republican Party administration.



Sieg Bread and the attrition The Uni-variate


Finds that

of power: Economic Autoregressive

unemployment falls

events and German Moving Average

before and increases

election results.

(ARMA) for

after election;

unemployment and

decreasing inflation

Phillips curve

before elections,

hypothesis and

increment in the


public budget deficit

integrated moving

in election year, GDP

average (ARIMA) for

growth and decline in


government investment in election years.

Dopke Pierdzioch (2004)

Goodell Vahamaa, (2012)

and Politics and the stock Acceptance functions

Find contrast to some


and vector

experimental proof of


autoregressive (VAR)





and Presidential elections The VIX volatility and implied volatility: index




Reveal that the uncertainty surrounding various





stock market

political uncertainty

increases as the winner chances becomes less uncertain.

Savita and Ramesh Return volatility

The traditional market Find high positive


model of event study

around national

cumulative average

elections: Evidence

abnormal returns

from India

(CAAR) of different election period for the event windows.

Akkoc and Ozkan, An (2013)

empirical The


model confirm their

investigation of the (MM)

opposition to

uncertain information


hypothesis: Evidence

prediction that is

from Borsa Istanbul

uncertainty information hypothesis

Klose (2011)


Business Panel-GMM

Find evidences of

Cycles and Monetary methodology

political business

Policy Revisited – An

cycle in monetary


activities affirming




the dependence of the




monetary regulators

Reaction Function. Eriki and Eboigbe Presidential (2012)

on incumbent leader.

election The traditional market Find a post-elections

and stock prices in model Nigeria: An



CAR testing kits


and decline in stock returns evidenced by low standard deviation. The study also reveal that the electoral effect of 2007 was the worst perhaps due to changes from one person to another within the same political party (PDP).

Mensi, Boubaker Managi (2013)

Beljid, Correlations and


Evidence of


substantial diffusion

across commodity


between S&P 500

and stock markets:


and commodity

Linking energies,



food, and gold


manifested therefore


revealing that shocks

and volatility spillovers


and instability in capital markets substantially affects global oil prices, gold and other durable commodity markets indicator.

Source: Summarize by the author. From these empirical studies summarized with various methodologies, it is obvious that aggregate economic indicators co-move with political events at the national and international level. It is our opinion therefore that there exist a gap driven by heterogeneities and simultaneities of the competitively opposing national policies. This is predicated on lack of policy restrictions to the behavioural components of investment philosophies. 2.3.8 Schematic Relationship of Some Macroeconomic Indicators. From the illustrations below, it is therefore correct to say that deliberate and selfishly articulated policies has a way of impacting negatively of the aggregate economic indices. Here, the political players in connivance with different agencies within and outside the government could reinvent the wheel of efficient market forces driven economy.


Time-bound Target (reduced unemployment rate,stable price & exchange rate,increase output,increase global rating etc

C: Intermediate target (endogenuosly determined by incumbent Government)

A1:Fiscal policy instrument (deficit budget finaning,Expansionary fiscal policies,tax holiday,subsidies,differe nt interventionist scheme etc

A2:Monetary policy (Apex Banks MPR,Money supply,Exchange rate manipulation etc

B: Policy instrumental interplay :Endogenuosly (within the national agencies) and Exogenuosly (outside the national boundries)

A3: Globalization,heterogen uos and simultaneous effect given credence to by respected agencies actin plan eg AID etc

Figure 2.1 Schematic Relationship of Macroeconomic Indicators. Source: Author, 2016 From the chart above, it is evidence that endogenously and exogenously induced policies ultimately transmit its respective direction to the event or time-bound targets of the government in power. A1 + A2 = C; A1 + A2 + A3= B; C + B = D OR B = D (Time-bound targets)


Interim/short term Target e.g Electoral victory,stable price, and exchange rate,output growth etc

CBN Monetary policy framework NBS/SEC/NSE Increase money supply (through sales of Govt securities,incre ase bank credits at reduced interest rate etc)

through supervision of regulatory guidlines Lowering of interest rates to increase investment expenditures which create jobs Discouraging insider trading and other unethical practices that gives the market a credible outlook

Figure 2.2 Schematic Relationship of Macroeconomic Indicators (internal)


(A) BEFORE ELECTIONS: Pre-election dates. Policy Expansion including Tax holiday,reduced interest rate,increase public expenditure,introduction of different interventionist schemes etc

(B) Election related incentives: reduced uneployment rates, increase output, lower interest rate and other economically unjustifiable indices

(C) Post elections: swallowing the bullets inform of contractionary policies such as high interest rate, weakened exchange rate,high unemployment rate,massive job losses,

Figure 2.3 Schematic representation of this study. Source: Author, 2016 The tendencies for each of these elements to impact on the aggregate economic indicators is a function of the strength of national institution, the depth and breadth of the financial markets as well as the political consciousness of the electorate. Also of essence is the direction of the various international interventionist schemes like Aid and Grants from donor agencies within the electoral cycles.


CHAPTER THREE METHODOLOGY 3.1 INTRODUCTION This section presents the procedures, specify the various model and highlight steps deemed relevant to the study based on the nature of the data as well as the estimating procedures. These includes research designs, model specification, and population of interest, samples, data sources as well as various estimation techniques. 3.2 RESEARCH DESIGN The research adopts the panel and longitudinal survey approach using the historical data of the various indices. This is adopted due to the desire to establish the trend of events within a period so as to test the effect of specific events on various dependent sets of economic variables. 3.3 POPULATION AND SAMPLE SIZE The population of interest here are those of independent democratic countries of the global community. The sampled size as highlighted earlier in the scope of this study includes United Kingdom, United States of America, Japan, China and Hong Kong as well as Egypt. Also on the list are Republic of South Africa, Brazil, Nigeria, France and Germany. This is with a view to review globally the effect of political events on capital market and national economic indices. A look at the list reveals that the countries stable democratic culture as well as leaders in their respective economic and sub-regional groupings. The sampled countries are all in the first forty largest economy hence their use to substantiate globally acceptable economic and investment decision theories. Besides, availability of dependable and credible data from recognized global 63

agencies further justify our choice and the sampled size of the countries and variables of our interest for the study. 3.4 SOURCES OF DATA Data for the study were sourced from various international regulatory and rating agencies. Such agencies as Morgan Stanley Capital International (MSCI) which was designed to measure equity market performance in global and emerging markets, World Bank and Trading Economics. Nigeria firm specific data were sourced from the Nigerian Stock Exchange (NSE). 3.5 THEORETICAL FUNDAMENTALS AND MODEL SPECIFICATION In this section, we highlight various models that enabled us to operationalize the various theoretical foundations. 3.5.1 Opportunistic Political Business Cycle Model (Policy Stance and Output, Employment, and Inflation) The theory of political business cycles which considers fiscal or monetary agents’ reflections from political and election biases in carrying out their activities, was initially developed by William Nordhausin 1975. Here we relied on the Phillips-curve relationship which presupposes a trade-off between inflation and unemployment rate. Investigations based on this theory consider a government wishing to be re-elected and basing its bid on its ability to control fiscal and monetary aggregates to favour their position. Thus, our focus is on both monetary responses to political ambitions and how these create cycles in the economy over time. For monetary policy, our modelling pattern focuses on how the tool of interest rate or money supply are manipulated by the monetary authority in order to perpetuate their employers’ political interests. The argument is that the central bank in a country can help re-elect the incumbent leader 64

(or party) by a policy stance that is expansionary just before an election. Given that the goal of monetary policy is to boost employment or maintain low inflation, the pattern of policies during elections tend to create cycles in these economic variables over time. The rationale for this policy outcomes is that, at least, the governor of the central bank will be sympathetic with the incumbent since the governor was appointed by the incumbent. For this study, we follow strictly the Nordhaus model based on the Phillips rule–the trade-off of policy outcomes between low inflation and reducing unemployment (output expansion in this study). This approach for monetary policy is often conducted within the standard Taylor (1993 & 2000) reaction function which was proposed for explaining the interest rate setting behaviour of the Federal Reserve Bank during the period 1987-1992. This function tends to cover the rule that the central bank follows during high inflation or unemployment (low output growth). It is argued that central banks react to deviations of the inflation rate from its target and to deviations of output from their potential, the so-called output gap. In general, the Taylor reaction function to any deviation can be written as: 𝑇 𝑚𝑝𝑖𝑡 = (𝑖̅𝑖𝑡 + 𝑚𝑠 ̅̅̅̅𝑖𝑡 ) + 𝑎𝜋 (𝜋𝑖𝑡 + 𝜋 ∗ ) + 𝑎𝑦 (𝑦𝑖𝑡 − 𝑦̅𝑖𝑡 ) + 𝜀𝑖𝑡


Where mp is the adapted Taylor monetary policy instrument set by the respective central bank in period t. This instrument can be taken as interest rate, i, or money supply, ms; 𝑖̅𝑖𝑡 and 𝑚𝑠 ̅̅̅̅𝑖𝑡 are the equilibrium interest rate and money supply respectively; 𝜋𝑖𝑡 and 𝜋 ∗ are the inflation rate and its target, 𝑦𝑖𝑡 is the output measure; 𝑦̅𝑖𝑡 is the potential output level (in our case industrial production); and 𝑎𝜋 , 𝑎𝑦 are coefficients to inflation and the output gap respectively. In this model, the policy tools of money supply and interest rate can affect aggregate expenditure, either directly (by money supply changes) or through investment changes (arising from the effect of monetary policy rate on real interest rate, r).


From the Fisher equation of monetary policy with static expectation, the central bank (aiming at adjusting current inflation) sets monetary policy interest rate at a proportion that is higher than the rate of inflation. This is expected to be a rate that will make real interest rate to be a premium on the inflation rate such that: 𝑖̅𝑖𝑡 = 𝑟̅𝑖𝑡


Where 𝑟̅𝑖𝑡 is the real interest rate. Based on this principle, equation (3.5.1) can be re-written for the monetary policy rate effect as: 𝑇 𝑖𝑖𝑡 = 𝑟̅𝑖𝑡 + (1 − 𝑎𝜋 )𝜋 ∗ + 𝑎𝜋 𝜋𝑖𝑡 + 𝑎𝑦 (𝑦𝑖𝑡 − 𝑦̅𝑖𝑡 ) + 𝜀𝑖𝑡


Here, 𝑎𝜋 =(1 − 𝑎𝜋 ). Equation 3.4.3 presents the implication of the Taylor rule model. In this model, whenever inflation deviates from its target level, the interest rate has to be above the inflation rate. This leads to an increase in the monetary policy rate (MPC) the key variable for general investment decisions. Apparently therefore, the coefficient 𝑎𝜋 has to be larger than unity to fulfill this principle. As in the original Taylor model, we assume a continuous equilibrium MPC and price increases which when combined into the constant, yields equation (3.5.4) as: 𝑇 𝑖𝑖𝑡 = 𝑐 + 𝑎𝜋 𝜋𝑖𝑡 + 𝑎𝑦 (𝑦𝑖𝑡 − 𝑦̅𝑖𝑡 ) + 𝜀𝑖𝑡


Equation (3.5.4) can be easily estimated to present the Political Business Cycle for the monetary policy rate manipulation by the central bank to favour the political interest of the incumbent. This equation can also be adapted for the money supply as an instrument of inflation and output control by the central bank. The model is presented as: 𝑚𝑠𝑖𝑡𝑇 = 𝑐 + 𝑎𝜋 𝜋𝑖𝑡 + 𝑎𝑦 (𝑦𝑖𝑡 − 𝑦̅𝑖𝑡 ) + 𝜀𝑖𝑡


Where all variables are as earlier defined. The proposition from this models (3.5.4) and (3.5.5) is that the central bank is willing to sacrifice its cherished goal of maintaining low inflation over time, by conducting a policy stance that will effectively boost employment (or improve output) at 66

any given period of election preparation in order to favour the incumbent government. These imply that pre-elections inducement to lower rate of unemployment with a disproportionate effect on rate of inflation is significantly higher than non-electoral events windows. Equations (3.5.4) and (3.5.5) were the starting point for the main analyses of the relevant hypotheses. Next, we try to see the different reactions on the political business cycle and an interval indicator to Taylor’s reactionary functional equations whether before or after an election. The equations become: 𝑇 𝑖𝑖𝑡

= {

[𝑐𝐵 + 𝑎𝜋𝐵 𝜋𝑖𝑡 + 𝑎𝑦𝐵 (𝑦𝑖𝑡 − 𝑦̅𝑖𝑡 )] [𝑐𝐴 + 𝑎𝜋𝐴 𝜋𝑖𝑡 + 𝑎𝑦𝐴 (𝑦𝑖𝑡 − 𝑦̅𝑖𝑡 )]



} + 𝜀𝑖𝑡


In equation (3.5.6), A and B indicate the state of monetary authority interest rate stance pre and post-election periods. Thus, the two equations within the Heaviside indicator show the policy stance of the central banks with respect to interest rate changes before and after an election. Also, period j, represents before the election, while k represents period of time within which the central bank can aid the incumbent in winning the election. The break in periods of two dissimilar states indicates that pre-election period j has k months wherein the bank decides to influence incumbent chance of victory using a suitable monetary policy. Consequently, k months also exist for postelections when incumbent government do not need such assistance wherein the bank upholds its mandate. The month in which the election takes place is not included in the model since the election dates may vary within the month and year for different countries (e.g. run-off elections). In determining the period k, it is obvious that central banks may not have an exact period when they are expected to alter their policies so as to assist the incumbent government. Hence, different time horizons for k is used in the study ranging from k = 3, 4, 6… 12. Given the frequency used in


the analysis, k is in terms of months. The option of 3 months is chosen because of lags in policy decisions effect on the economy (Iyoha, Oyefusi and Oriakhi, 2003 & Mankiw, 2008). This implies that one month before the event may not actually have the expected effect on the economy that could sway the voters’ choice. This model can also be specified for money supply equation as: [𝑗−𝑘,𝑗−1]


[𝑐𝐵 + 𝑎𝜋𝐵 𝜋𝑖𝑡 + 𝑎𝑦𝐵 (𝑦𝑖𝑡 − 𝑦̅𝑖𝑡 )] = { } + 𝜀𝑖𝑡 [𝑗+1,𝑗+𝐾] [𝑐𝐴 + 𝑎𝜋𝐴 𝜋𝑖𝑡 + 𝑎𝑦𝐴 (𝑦𝑖𝑡 − 𝑦̅𝑖𝑡 )]

What are the apriori expectations for the coefficients? In the first place, equations (3.5.5) and (3.5.6) only show whether central bank tries to alter interest rate or money supply and other monetary policy components to achieve the desired inflation rate, level of industrial output as well as other macroeconomic indices for the different election periods. The equations do not actually indicate the existence of political business cycle theory on the banks regulatory policy. To identify an opportunistic political business cycle effect, interest rate ought to be lower regardless of output position in pre-election windows. Therefore, a negative coefficient for output gap in the previous case (where output is above potential) and positive coefficient for the latter case is a pointer to OPBC postulations. After the election, it is expected that there should be no above- or lower than output responses. In this case, the traditional Taylor constant coefficient could be applied. Hence we test the equality of the ayA coefficient with that of CA for the post-election period. Essentially, since differences exist before electoral events occasioned by output gap, the indicator model is respecified in order to validate the expectations. This is presented as: [𝑐𝐵𝐸 + 𝑎𝜋𝐵𝐸 𝜋𝑖𝑡 + 𝑎𝑦𝐵𝐸 (𝑦𝑖𝑡 − 𝑦̅𝑖𝑡 )] 𝑇 𝑖𝑖𝑡


[𝑐𝐴𝐸 + 𝑎𝜋𝐴𝐸 𝜋𝑖𝑡 + 𝑎𝑦𝐴𝐸 (𝑦𝑖𝑡 − 𝑦̅𝑖𝑡 )]

[𝑗+1,𝑗+𝐾]∧𝑦𝑖𝑡 >𝑦̅𝑖𝑡

[𝑐𝐵𝐶 + 𝑎𝜋𝐵𝐶 𝜋𝑖𝑡 + 𝑎𝑦𝐵𝐶 (𝑦𝑖𝑡 − 𝑦̅𝑖𝑡 )] {[𝑐𝐴𝐶 + 𝑎𝜋𝐴𝐶 𝜋𝑖𝑡 + 𝑎𝑦𝐴𝐶 (𝑦𝑖𝑡 − 𝑦̅𝑖𝑡 )]

for monetary policy rate, and 68

[𝑗−𝑘,𝑗−1]∧𝑦𝑖𝑡 >𝑦̅𝑖𝑡

+ 𝜀𝑖𝑡

[𝑗−𝑘,𝑗−1]∧𝑦𝑖𝑡 𝑦̅𝑖𝑡

+ 𝜀𝑖𝑡