There are times when the price movement in the stock market can’t be explained by their fundamental factors, sometimes also referred as market anomalies as the stock price moves away from their intrinsic value. This is where behavioral finance comes in, the theory proposes that the behaviors of investors and financial professionals are affected by psychological influences and biases.
Behavioral factors are used to explain noise traders whose investment decisions are affected by emotions, these traders plays a huge role when stock prices move away from their intrinsic value. A study by Baker and Wurgler in 2006 found that there are more sentiment-sensitive stock found in developing countries (such as Indonesia) compared to developed countries. These sentiment-sensitive stocks are vulnerable and subjects to the behavioral capital asset pricing theory which introduced by Shefrin and Statman in 1994. The theory suggested that when bullish sentiment dominates the stock market, investors and traders buys more stock and prices will move above their intrinsic value; however when a bearish sentiment dominates, investors and traders will sell more stocks and prices will dragged below their real value.
Political risk is one of the factors which associated with behavioral finance. Studies found that political shocks can cause the stock market to either overreact or underreact which may lead to the fluctuation of the stock price. On the other hand, a stable political environment plays a huge role in a good performing stock market.
Political Risk in Indonesia
Thampayana and Wu in early 2020 suggested that Indonesia, compared to the other four countries in the ASEAN-5, has the biggest political risk. Unstable political landscape and policies issued by the government are some of the factors that might affect the political risk in a country.
Public Distrust to How the Government Respond to COVID-19
When the news about the coronavirus pandemic spread, Indonesian political leadership was relatively slow to respond. Even after the first case was reported in early march, there were distrust towards political leaders as many believed the government were not able to get the pandemic under control. The absence of strict social distancing measures and inefficient health resource mobilization strategies were to name a few of the factors why the country still struggling to control the spread of the virus.
The Controversial Omnibus Law on Job Creation
Despite public protest and rejection, surprisingly, the Indonesian House of Representatives was speeding up the discussion on the decision-making of the Job Creation Bill. Some of the most commonly addressed issues were potential environmental fallout, endangerment of worker’s right, and procedural flaws. Not to mention that many academics were worried about the bill since there were a limited time allocated for deliberation and poor participation of stakeholders.
How Indonesian Political Risk Affect The Stock Market
In countries with high political risk, political dynamics and policy issued by the government are affecting on how investors make their investment decisions. Negative sentiment, for example, are causing foreign investors to release their shares and invest in other countries. In addition, the Indonesian capital market is relatively a weak capital market, therefore investors are very sensitive to changes that occur in the country, especially those related to political factors.
A study by Thampayana and Wu also suggested that behavioral factors plays a bigger role than fundamental factors in affecting market volatility in Indonesia as a result from measures taken by investors due to unstable political environment.
To sum up, behavioral factors comes into play when the price move away from their intrinsic value. In Indonesia, due to its high political risk, investors decision is sensitively affected to changes that occur in the political condition of the country, which ultimately lead to the increase of market volatility.