Credible Reforms and Stock Return Volatility : Evidence from Privatization

In this paper we investigate how the progress of market-oriented reforms such as privatization affects stock return volatility and how this impact varies with the level of economic development. We show that privatization is related to volatility via political risk. Indeed, a privatization program maintained over time signals government credibility, and this process gradually resolves political risk and reduces volatility. Volatility decomposition shows that the sustainability of the privatization program is associated mainly with lower idiosyncratic volatility among developed markets, while it is strongly related to the systematic volatility of developing markets. Additional tests suggest that the reduction in volatility components is greater when a sustained privatization program is carried out through the stock market. Finally, our results indicate that although all public firms benefit from the resolution of political risk, firms that are fully or partly government-owned experience a greater reduction in volatility