Democracy, political risks and stock market performance

• The relationship between the level of democracy and political risk is parabolic.
• We argue that this is reflected in the equity market returns.
• Issue is examined with a panel data on 49 emerging equity markets.
• The relationship between political risk and equity returns is found to be positive.

This study examines the impacts of democracy and political risk on stock market. Using annualized panel data for 49 emerging markets for 2000–2012 we find evidence that democracy and political risk do have impact on stock market returns and the relationship between democracy and political risk is parabolic, i.e., there is a threshold level of democracy after which political risk begins to decline. Also our results suggest that decreases in political risk lead to higher returns.