Politics are dominating financial markets. Day after day, prices react to news about what governments around the world have done or might do.

The markets were jubilant two weeks ago when European politicians announced a deal cutting Greece's debt in half. U.S. stocks soared 3.4 percent on Oct. 27, while French and German stocks gained more than 5 percent. Early last week, equities gave back those gains when Greece's prime minister, George Papandreou, announced his intention to hold a referendum on the bailout. When other Greek politicians voiced their opposition to that initiative, markets rejoiced again.

It is stunning that the pronouncements of politicians from a country whose gross domestic product is smaller than that of Michigan can instantly create or destroy hundreds of billions of dollars of market value around the world.

Yet, despite its obvious importance, political uncertainty is notably absent from mainstream finance theory. Indeed, it would be a waste of time to search financial textbooks for models that take into account uncertainty about future government actions.

In a recent paper, we tried to fill this void by developing a simple model of financial markets in which the government has the option to intervene. Since the officials' political motives are somewhat unpredictable, investors cannot fully anticipate what a government is likely to do.

How do governments affect stock prices? Our model highlights two opposing effects.

David Fuller's view I think the high degree of correlation, mentioned extensively in the latter portion of this article which I commend to you, has a great deal to do with short-term trading relative to investing.

Before futures contracts, which I have always maintained are a great innovation, stock market activity was dominated by investment decisions, including the selection of sectors and individual shares to buy or sell.

From the mid-1980s onwards this began to change with the introduction of stock market futures contracts which enabled active investors to achieve either long or short exposure to a large selection of equities much more quickly. The proliferation of large proprietary trading desks in financial institutions followed, as did hedge funds.

The shorter the time horizon of trading, the more likely it is to be influenced by major news items, not least regarding political events viewed as potentially of economic significance. Once in motion, the shift in sentiment can quickly develop into self-feeding momentum moves.

More recently, the last decade's development of high frequency algorithmic trading (HFT) run by computer programmes has vastly increased the emphasis on short-term trading. HFT now accounts for 60 to 70 percent of turnover in the US stock market and is rapidly increasing elsewhere.

A predictable consequence is the persistently higher rate of market volatility which is becoming the norm. The political event trigger in this process is merely the first domino to fall, although its impact is increased by instant electronic communication.