Tomorrow, I will present a recent research written with Joshua Aizenman at the 4th IEAP Meeting: Investor Emotions & Asset Pricing in Lille at the IAE Lille. The paper is available on the NBER website:
https://www.nber.org/papers/w33193
Our identification strategy for the causality relies on the reaction of exchange rates after the path of victory appeared certain at November 6 UTC 0:00. The reaction on the foreign exchange market was so strong in a few hours, that it left very few doubts about the identification strategy. If the election of Donald Trump was anticipated, the FOREX would have priced this information before November 6 UTC 0:00 UTC and the exchange rate should have started to depreciate before midnight. It is not the case. For the euro area, 1 USD was equal to 0.914627 EUR at November 6 UTC 0:00 UTC and started to depreciate only after midnight.
Countries with better institutions are the more democratic and pro-trade countries. Thus, the markets expect that the new US administration will be make more aggressive move against this group of countries on immigration (Canada), military spending (European NATO members), and trade (Germany, Japan, etc.) and so on. This may mark the expectation of a new cycle in international relations in which having good institutions does not guarantee good relationships with the US.
We were surprised to find these results, and it makes sense if you consider the nature of the Republican platform for the 2024 US presidential election. So the quality of institutions may be understood in the context of this study as a way to distinguish countries which are more exposed to changes in trade, immigration, military spending and so on made by the new Trump administration.
The exchange reaction has probably priced these expectations.