Jump risk of Presidential election: evidence from Taiwan stock and foreign exchange markets

Abstract

This article employs jump-diffusion models, including the ARJI model and the GARCH-jump model, to examine jump intensity and volatility of Taiwan stock and foreign exchange markets during a Presidential election period. The empirical results indicate that, firstly, the ARJI model fits data better than the GARCH-jump model. Secondly, the Presidential election events enhance the jump intensity of both markets and the jump-induced variance is higher than diffusion-induced variance. It reveals the importance of the discrete jump process during a Presidential election period, and might provide some implications for option pricing or hedging strategy. Due to the intervention of the Central Bank in the foreign exchange market during a Presidential election period, the results indicate that jump intensity and volatility of jump size are more moderate.

Notes

¹ The election of the 9th President in 1996 is the first-ever popular election in Taiwan.

² Applications of a GARCH-jump mixture model have been given by Jorion (1988), Vlaar and Palm (1993) and Nieuwland et al . (1994).

³ Das (1988), Fortune (1999) and Eraker et al . (1999) propose different methods to model the time-varying jump intensity.

⁴ Some 120 days prior to the end of the terms of office of the serving President and Vice President, the Central Election Commission issues an election proclamation for the election of the President and Vice President.

⁵ See Ball and Torous (1985), Jorion (1988).

⁶ The empirical results by Jorion (1988) indicate that the fraction of the variance caused by jump component is 96% for the $/DM rate, much higher than the 36% figure for the stock market.

⁷ Trading volume of stock (secondary) and OTC markets during research period is 89.85 and 8.61 billion, respectively.

⁸ There are 13 and 6 times interventions of Central Bank during the 9th and 10th Presidential election period, respectively.

⁹ The jump probability means the ex post probability of at least one jump and can be calculated as .

¹⁰ The Central Bank intervened in the foreign exchange market on 25 and 26 February 2000 and announced to stabilize the exchange rate on 1, 4 and 16 March 2000.

¹¹ According to the statistics of the Taiwan Stock Exchange Corporation, the trading percentage of natural person is greater than 70% during 1994 to 2003.