Political uncertainty and stock market liquidity, size, and transaction cost: The role of institutional quality

Abstract Using panel data of 42 countries from 2001 to 2019, we examine whether political uncertainty (caused by uncertainty about national elections) explains variations in cross‐country liquidity, market size, and transaction cost. We also investigate whether institutional quality moderates the negative effects of political uncertainty on stock market development. We show that political uncertainty reduces stock market size, liquidity, and increases transaction costs. Our results indicate that institutional quality moderates the negative effects of political uncertainty on stock market development. However, we find no effects in emerging markets arising from the high prevalence of weak institutions. We confirm the robustness of our findings using alternative financial development measures and endogeneity. This study enhances our understanding of the salient role of political uncertainty in the development of the stock market, with important implications for market regulators, corporations, and investors.