Mr. Rows: An Empirical Study of the Presidential Elections Effect On Stock Market in Taiwan, South Korea, Singapore, Philippine, and Indonesia

LING-FANG LIU

A dissertation presented in part consideration for the

degree of MA Finance and Investment

The University of Nottingham

2007

Abstract

The behavior of stock market around election periods has been investigated for several decades but the presidential elections held in Asian countries have not been analyzed in the previous studies. The main objective of this study is to examine the return pattern around presidential election period in the stock markets of Taiwan, South Korea, Singapore, the Philippines, and Indonesia during the sample period 1996-2005. It has been found that stock markets generate positive abnormal returns fifteen-day period before and after the presidential elections, and that the magnitude of abnormal return is greatest in the presidential elections held in less-free countries when an incumbent loses. In addition, other financial and political factors have been found to play an important role in influencing the return pattern around presidential elections. This dissertation may be of interest to investors and financial analysts, especially those who intend to put money into Asian stock market during the coming South Korea 2007 and Taiwan 2008 presidential elections.

Introduction

One of the most fundamental theories in financial economics is the theory of market efficiency. In an efficient market all available information will be embodied in the stock price implying that investors cannot earn abnormal returns. Although the theory of market efficiency has been widely known in the real world, the various studies that investigate capital market efficiency have detected a large number of market anomalies that question the view on the efficiency of the markets. Some of the most profound market anomalies that have been found are as following. The P/E effect: Basu (1977) discovered that portfolios of low P/E ratio stocks have higher returns than do high P/E portfolios; The size effect: Banz (1981) found that the average annual returns are consistently higher for small than in large firms’ portfolio; The Fama and French three factor model: Fama and French (1993) found that the group with the highest book to market ratio outperformed those with the lower ratio; Seasonalities: Fama (1965), Bonin and Moses (1974) detected that stocks exhibit significant lower returns over the period between Fridays close and Mondays close. In addition, returns are much higher during the month of January than in any other month.

Besides these anomalies which are related to firms’ characteristic and special trading time, a large number of studies have discovered the pattern of common stock returns over the presidential elections.

Allvine and O’Neill (1980) presented strong evidence in support of the relation between stock market returns and the presidential election cycle. They found that stock market had a rising trend over the two years prior to the United State’s presidential elections. Also, Huang (1985), Smith (1992), and Johnson et al. (1999) investigated that stock returns were significantly higher in the second half of the presidential term. However, these researches were constrained on the relationship between U.S. stock market and presidential elections.

In 2000, Pantzalis, Stangeland, and Turtle are the first researchers to examine the behaviour of stock market indices around political election dates in an international scale. Their findings displayed that positive abnormal returns lead up to the election week, and that the positive returns are shown to be a function of country degree of political, economic, and press freedom and a function of election timing and the success of the incumbent in being re-election.

Objectives

Although the study mentioned above have gathered a large number of election samples to examine the market behaviour around election dates, the presidential elections held by Asian countries in recent years were not included in the sample pool. As a result of the lack of empirical testing on the effect of Asian presidential elections on stock markets, this dissertation will concentrate on the stock markets of five Asian countries- Taiwan, South Korea, Singapore, the Philippines, and Indonesia that hold presidential elections in the period of 1996-2005 to examine their return patterns around elections. By analyzing these countries market behaviour, the following questions can be addressed:

1. Are there abnormal returns during pre-election and post-election period in Taiwanese, South Korean, Singaporean, Philippines, and Indonesia stock markets?

2. Does the political and press freedom rankings difference among these countries influence the level of abnormal returns during election period?

3. Does the outcome of elections (incumbent win or lose) influence the level of abnormal returns during election period?

4. Are there any other potential financial or political factors leading different level of abnormal return among these countries? Structure

The rest of the chapters within the dissertation are organized as follows. Chapter 2 gives a brief overview of the political background and stock market development of the five sample countries. Chapter 3 reviews previous empirical studies that analyze the stock market return pattern around elections and provides possible theories to explain the return pattern. Chapter 4 describes the data and methodology adopted in this dissertation. Chapter 5 presents the empirical results of the dissertation and analyzes the findings with literature reviewed. Chapter 6 summarizes the conclusions, limitations of the study and recommendations on future research directions.