Scuttle for shelter: flight-to-safety and political uncertainty during the Spanish Second Republic

The Spanish Second Republic was a unique experiment of democratization in interwar Europe, which was characterized by extreme levels of political uncertainty. In order to study how investors responded to shifts in political uncertainty, we constructed a news-based monthly index of political uncertainty using the digitized historical collection of ABC, the most important conservative newspaper of the time, widely read by investors. We also used hand-collected data from bulletins and yearbooks of the Madrid Stock Exchange to calculate monthly total returns on government bonds and on a capitalization-weighted stock market index. We find that investors responded to shifts in uncertainty by selling stocks in favor of government bonds—a behavior known as flight-to-safety. Additionally, we find that political uncertainty caused stock market stress and induced significant differences in the cross-section of expected stock returns, consistent with the exposures to political uncertainty. The fact that investors recurrently scuttled to shelter into government bonds suggests that they did not perceive a radical change in the political regime as an immediate and credible threat.