Informational feedback between voting and speculative trading

Abstract

This paper develops a model to investigate the interaction between collective decision making in voting and financial speculation. Protesting voters demand policy reforms by voting against the incumbent, but too many opposing votes result in an unfavorable outcome: a political regime change. Traders speculate on the change of the political regime. The size of the speculation informs voters about the electorate's composition, thereby influencing the outcome of the election. We find that, in equilibrium, the strategic substitutability of protest voting makes speculations strategic substitutes via informational feedback, thereby incentivizing speculators to trade less on the correlated public signal. This strengthens the role of financial markets in providing information and amplifies the impact of the financial market's information on ex post political outcomes. We relate our theory to the Brexit referendum, and further discuss the robustness and limitations of our findings by considering more general information environments and voter preferences.