Monday, February 27, 2006

Stock markets and the budget

Everyone is now curious about the budget. It is natural to think of an event study of index fluctuations surrounding budget day. Susan Thomas and I did this in an EPW article in 2002. The quick result, visible in the graph above, is: on average, a budget speech is worth a 10% rise in the index.

What is fascinating is that all this rise takes place before the date of the speech. We see this as some kind of strongform efficiency proposition. Informed traders seem to be quite aware of what is brewing inside the Ministry of Finance and are able to incorporate this into prices in the 40 trading days prior to budget date.

Ila Patnaik has an excellent article in Indian Express on the evolution of the budget speech as an institutional mechanism. There is much more to the budget speech than taxation and expenditure: it has shaped up as a tool for transparency and a commitment device in coalition politics. This is consistent with the idea that you got a +10% return on average associated with budget dates. This reflects the surprises on a broad swathe of economic policy embedded in the speech; not just decisions about taxation and expenditure.

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