Political uncertainty, risk of Frexit and European sovereign spreads

ABSTRACT

Using data from a prediction market (crowd-based forecasts), we build a daily measure capturing the risk of Frexit related to the 2017 French presidential elections. We study how unexpected changes in this new measure of political uncertainty in France affect European sovereign spreads vis-à-vis Germany. We show that our uncertainty proxy drives not only the French sovereign spread but also the spreads of those EU countries deemed the most vulnerable to the risk of desegregation of the Euro Zone. These results suggest that specific political uncertainty affects short-term investor’s expectations and may outweigh other economic determinants of sovereign spreads shortly prior to high stake elections

KEYWORDS:

• Prediction markets
• political uncertainty
• sovereign debt
• interest rates

JEL CLASSIFICATION:

• H63
• D84
• E49

Acknowledgements

We thank Vincent Bignon for very useful comments and Emile Servan-Schreiber (Hypermind) for the data. The views expressed here are those of the authors only and do not necessarily reflect the views of the Banque de France or the Eurosystem.

Disclosure statement

This paper should not be reported as representing the views of the Banque de France.

Notes

¹ Data from the same predictive market were used in Coulomb and Sangnier (2014) who study the impact of political majority on firm value in the 2007 French presidential election.

² In principle, could become negative if the far-right party becomes the favourite for the French election. As it is shown in Figure 2, it does not occur in our sample.