Political Uncertainty and Sovereign Bond Markets

We analyze the effects of political uncertainty on prices and liquidity of sovereign bonds. Specifically, we investigate Italian government bonds during the European sovereign debt crisis and focus on political summits and elections. We find a significant drop in prices in combination with high illiquidity and sell-side pressure before the events. The event returns are significantly positive and followed by a positive price trend. The effects are stronger when uncertainty, as measured by the EPU index, is high and economic conditions are weak. In addition, political uncertainty also affects the primary market and we find significant costs associated with issuing sovereign bonds in highly uncertain times.