The Impacts of Political Uncertainty on Asset Prices: Evidence from a Natural Experiment

Models for political uncertainty risk predict that increases in political uncertainty will cause stock prices to fall, especially for politically sensitive firms. We use the Bo Xilai political scandal in China in 2012 as a natural experiment to identify the impact of political uncertainty on asset prices. We document that the Bo scandal caused a much more significant drop in the stock prices of firms that were more politically sensitive. Further analysis shows that our evidence is mainly driven by the change in discount rate, providing strong support for the existence of political uncertainty risk. * We appreciate the helpful comments and suggestions from Sugato Bhattacharyya, Sudipto Dasgupta, Chunxin Jia, Kai Li, Qiao Liu, Xuewen Liu, Yu-Jane Liu, Rik Sen, Ya Tan, Abhiroop Mukherjee, Jialin Yu, LongKai Zhao, Chu Zhang, and all participants in seminars held at the Hong Kong University, the Hong Kong University of Science and Technology, Peking University, and Zhongnan University of Economics and Law, and from all participants in the 107 th Annual Conference on Taxation organized by the National Taxation Association (NTA) in Santa Fe, U.S.A., and the Cross-Strait Capital Market Forum held at Feng Chia University in Taiwan. We also thank all students who participated in the 2013 Summer UROP program. Special thanks go to Chloe Ouya Tian and Gary Zhijun Zhang for excellent research assistance. We acknowledge financial support from the Research Grants Council of the Hong Kong Special Administrative Region, China (GRF 694413). The Impacts of Political Uncertainty on Asset Prices: Evidence from a Natural Experiment Abstract Models for political uncertainty risk predict that increases in political uncertainty will cause stock prices to fall, especially for politically sensitive firms. We use the Bo Xilai political scandal in China in 2012 as a natural experiment to identify the impact of political uncertainty on asset prices. We document that the Bo scandal caused a much more significant drop in the stock prices of firms that were more politically sensitive. Further analysis shows that our evidence is mainly driven by the change in discount rate, providing strong support for the existence of political uncertainty risk.Models for political uncertainty risk predict that increases in political uncertainty will cause stock prices to fall, especially for politically sensitive firms. We use the Bo Xilai political scandal in China in 2012 as a natural experiment to identify the impact of political uncertainty on asset prices. We document that the Bo scandal caused a much more significant drop in the stock prices of firms that were more politically sensitive. Further analysis shows that our evidence is mainly driven by the change in discount rate, providing strong support for the existence of political uncertainty risk. JEL Classification: G12; G14