Political processes – elections, cabinet formations, referenda, legislative debates – determine a government's economic policies, which, in turn, condition the environment for investment. By anticipating the results of these processes, savvy investors can re-allocate their portfolios to meet a changed policy context. Asset owners, therefore, have a keen interest in predicting political outcomes: Which party will win the election? Who will form the government? What will be the new government's policy priorities?

The collective decisions of investors, in turn, shape how markets respond to political processes. Whether markets react to political events in a systematic manner remains an open issue. Do asset prices behave differently when left parties are in office? Will the election of a particular candidate cause a run on the currency? Does divided government – where the executive comes from a different party than a majority of legislators – cause a market downturn?

The consequences of these market responses extend far beyond questions of portfolio allocation. The investment decisions of asset owners fundamentally shape economic performance. Shifts in asset allocation can sustain an economic upswing or cut-off growth. With the technological and financial integration of asset markets, price movements can cascade across borders and markets, creating a world-wide boom or a systemic crisis.

Changes in market conditions have distributional consequences as well. Economic actors reliant on the stock market for income – firms, pensioners, etc. – are vulnerable not only to falling equity prices but also to volatility in market returns.