Historiografía

Studies such as Driessen and Laeven (2007) assert that the benefits from international portfolio diversification are largest for countries with high country risk. Since it is found that the magnitude of political risk change remains larger in emerging than developed markets and that these two types of markets are still weakly correlated, this study shows that equity investing in emerging markets can provide investors with some diversification benefits.

This study provides further evidence that, at the aggregated portfolio level, there are no significant relationships between political risk and the aggregated portfolio returns of emerging and developed markets for the period of 1984 to 2007. However, political risk appears to be an important factor in explaining the stock returns of emerging markets subsequent to the 9/11 Terrorism Attack. The results from robustness test, however, suggests that this is due to the fact that emerging markets track the movement of US stock market following the shock of 9/11 event. An important inference from this is that if changes in political risk in the US can be predicted, this may help investors to forecast the pattern of stock returns in emerging markets to a certain extent. Moreover, such a finding highlights the possibility that political risk is to some extent accountable for the market comovement

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107 between emerging markets and the US stock market. However, a formal testing of market cointegration needs to be conducted so as to provide concrete evidence on this matter. This is left for future research.

While finding no relationship between political risk and the portfolio returns of emerging and developed markets, the results of the Pacific Basin emerging markets portfolio highlight a significant relationship between political risk and the stock returns of these markets throughout the sampling period. This relationship is particularly apparent in the last few years of the sample which includes the Asian Financial Crisis period. This study therefore adds to the existing body of knowledge that Pacific Basin emerging markets are more responsive to political risk than any other markets.

Accordingly, the findings from this study suggest that there are differences in political risk exposure among emerging, developed, and Pacific Basin emerging markets at the aggregate portfolio level. Such findings therefore raise an important awareness to investors that caution need to be taken on the type and location of their investments to ensure that they optimise the diversification benefits. In addition, they need to be aware that investing in Pacific Basin markets can increase the level of risk and affect the risk-return characteristics of their investment portfolios.

To conclude, given that there is evidence that political risk is an important determinant of stock returns, particularly for the Pacific Basin emerging markets, the next chapter presents the second essay of the thesis which examines a specific political risk component that appears

to be common amongst these markets. This is namely ‘Military in Politics’. It is a political

risk component that bases on the degree of military involvement in political affairs. Since

‘Military in Politics’ is one of the political risk attributes that increases the level of risk of a given country according to the PRS group, it is of interest to examine whether this type of governance is in fact a price factor for these stock markets; and, whether these stock market returns are indeed higher during periods of ‘civilian’ as opposed to ‘military’ governments.

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CHAPTER FOUR

ESSAY TWO:

POLITICAL REGIME & STOCK RETURNS

This chapter presents the second essay which investigates the differences between the stock returns of ten emerging markets under military and civilian regimes. A brief overview of the impact of political regimes on equity markets is provided in Section 1 of the chapter. Section 2 discusses the relationship between military involvement and stock markets. Section 3 proposes the hypotheses. Section 4 provides data description and descriptive statistics. Sections 5 and 6 present the test methodologies and empirical results, respectively. Section 7 outlines a series of robustness tests. Sections 8 and 9 discuss the results and conclude this essay, respectively.

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4.1 INTRODUCTION

The interaction between civilian and military governments is extensively studied by historians, political scientists, and sociologists but rarely by finance academics. Political scientists such as Huntington (1968) assert that military intervention in politics can reveal both the political and institutional arrangement of that society. By comparing between developed and emerging markets, the political situation in the latter markets appears to be more unstable than the formers since the changes in the governments and political leaders can be observed more frequently. There are several factors that cause these frequent changes in governments. These range from, for example, economic problems, wrongful seizure of political power to corruption and abuse of power by politicians. Often, such a shift in power creates internal political conflicts that lead to riots12. To restore order in a country, military interference in politics is regularly seen following these incidents (Pinkney, 1990). Generally, the period of military rule lasts until the state is in order and a proper general election is held to find a new democratic leader. However, for some countries, this military rule lasts for a much longer period of time and this invariably leads to a lengthy period of political uncertainty (May, Lawson, and Selochan, 1998).

Despite the fact that the aim of military interventions is usually to restore order in a country, many still perceive that such a military interference in politics causes adverse effects on the financial market. Studies such as May et al. (1998) find that apart from the social implications a direct political involvement by the military generally suppresses economic growth and freedom, which lessens the country’s overall credibility. As a result, this lowers

investors’ confidences and influences their investment decisions in the financial market. Both local and foreign investors could in this case delay or suspend their investments due to the perceived risks and uncertainties.

Nonetheless, there is not yet any direct empirical evidence showing the effect of ‘military’ governments on stock returns. The purpose of this study is to conduct an empirical study to fill this gap in the current literature. It is believed that emerging markets provide appropriate

12 _{For example, Sylvia and Danopoulos (2003) document that the overthrow of President Hugo Chávez of}

110 settings for conducting such type of research since most of them are relatively new democratic countries where corruption and abuse of power by politicians for personal interests are common problems (Khanna and Palepu, 2000; Dinç, 2005; and, Winichakul, 2008). Accordingly, emerging markets tend to have higher frequencies of political upheavals than developed markets and, as a result, military involvement in politics can be seen more regularly to resolve such political conflicts.

The main contribution to the existing literature is twofold. Firstly, this study is the first to examine the effect of military governments on stock markets. Therefore, it helps to fill in the gap in the current literature. Secondly, this study focuses on emerging stock markets. It is believed that an investigation and outlook on these markets are essential for investors, particularly during such periods of military interference since these markets are important venues in which investors diversify and hedge against the country-specific uncertainty of their local stock markets. An investigation of those markets where military intervention does occur can therefore have important implications for portfolio formation and the allocation of investment funds.

This study is organised as follows. Section 4.2 examines the relationship between military involvement in politics and its influences on stock markets. Section 4.3 proposes the research objectives and hypotheses. Section 4.4 provides data description and descriptive statistics. Section 4.5 outlines the test methodologies to be used. Sections 4.6 and 4.7 present the empirical results and robustness tests, respectively. Section 4.8 discusses the results and Section 4.9 concludes this study.