Democratization and sovereign spreads
In this paper, Tunçera and Weller test the “democratic advantage hypothesis” – that democratic governments can borrow more cheaply than autocratic ones – during the first era of financial globalization from 1870-1913. They analyze bond yield spreads for 27 peripheral, capital-importing countries that borrowed in London over this period. Political regime types are classified into 4 groups based on legislature power and executive selection method: True Autocracy, Presidential Democracy, Constitutional Monarchy, and True Democracy. the authors find that:
- In contrast to the democratic advantage hypothesis, democracies – specifically True Democracies and Constitutional Monarchies – had higher sovereign bond spreads than True Autocracies.
- True Democracies paid around 5.7% higher spreads than True Autocracies. This gap is equivalent to over one-third of the penalty imposed by defaults.
- The authors argue that creditors favored autocracies due to perceptions they provided greater political stability than democracies in the peripheral countries studied.
- An event study around regime changes also shows that democratization is associated with significantly higher spreads, while autocratization has no discernible impact.
Democracy, autocracy, and sovereign debt: How polity influenced country risk on the peripheries of the global economy, 1870–1913
Authors: Ali Coşkun Tunçera, Leonardo Weller
From: University College London, São Paulo School of Economics
Democratization and equity risk premia
Max Miller develops a model linking democratization risk to increases in equity risk premia. He argues that democratization redistributes resources from elites to citizens through higher taxes and regulation. This increases consumption risk for elites. As the probability of democratization rises, elites require higher returns to hold risky assets, driving up risk premia.
- The model is calibrated to match moments related to inequality, taxation, dividends, and asset prices in autocracies and democracies. In the model, the shift from autocracy to democracy causes a 19% increase in dividend yields, close to the 20% increase observed in the data during democratizations. Decomposing this shows over 80% is due to a rising equity risk premium.
- Miller tests the model using data on 20 countries over the last 150 years. Around democratization starts, dividend yields and stock return volatility increase while stock returns decline. These patterns are unique to democratizations – they do not occur around wars, financial crises, or other political shocks.
Who values democracy?
Authors: Max Miller
From: Harvard University
