Democratization, Inequality, and Risk Premia

Risk premia are significantly elevated during periods of democratization in a cross-country panel of equity data covering 85 countries over 200 years, despite little evidence of a negative effect on either realized or expected GDP and dividends. This result is explained in an asset pricing model in which wealthy asset market participants face higher taxes when democratizations succeed. Finally, using a shift in Catholic church doctrine in support of democracy, majority Catholic autocracies display significantly higher average excess returns relative to other countries in a difference-in-differences framework. These results shed light on how redistribution risk shapes asset prices.