Ms Yingluck proposed a decree for the dissolution and to call new elections to end weeks of street rallies in Bangkok. Demonstrators, who want the Thailand's democratic system replaced by an unelected council, said earlier the unrest wouldn't end even if she stepped down or dismissed parliament.
Elections would need to be held by Feb 2 at the latest under the constitution, government spokesman Teerat Ratanasevi said.
"This would calm market sentiment as the politics wouldn't be as big a concern as before," said Pareena Phuangsiri, an analyst at Kasikornbank Plc. "But in the longer term, it will still drag on because this is not what the demonstrators were asking for."
The baht advanced 0.1% to 32.129 per dollar as of 4.37pm, according to data compiled by Bloomberg. The currency fell as much as 0.5% earlier to 32.33 and reached 32.365 on Dec 6, the weakest level since Sept 9. The SET Index climbed 0.4% to 1,367.42 after rising as much as 1.2% earlier. The gauge is down 1.1% this quarter.
Global funds pulled a net US$587 million from local equities this month, adding to net sales of $1.5 billion in November, exchange data show.
The dollar's 14-day relative strength index (RSI) against the baht dropped to 67 on Monday from as high as 81 last week. A level above 70 suggests to some traders that the Southeast Asian currency was oversold and poised to change course.
"The house dissolution would give some short-term relief, but doesn't look like it would end all political concerns," said Koji Fukaya, chief executive officer and currency strategist at FPG Securities in Tokyo. "On the technical front, the RSI was above 80 last week and the baht was clearly in the oversold area. So it was natural to see some recovery in the currency at this point."
One-month implied volatility, a measure of expected moves in the exchange rate used to price options, slumped 10 basis points, or 0.1 percentage point, to 6.71%.
International investors have sold a net $5.5 billion of stocks this year, on course for the biggest annual outflow since Bloomberg began collecting the data in 1999. The SET Index is poised for its third straight quarterly slide. That would be the longest run of declines since 2009.
"The prime ministers action will help limit any further decline in the Thai stock market," said Win Udomrachtavanich, chief executive officer of One Asset Management, which oversees about $2.6 billion of assets. "Still, political uncertainty remains high because the protest leaders have insisted that the house dissolution wont meet their demand."
Government bonds rose as yields near a two-month high attracted investors. Overseas fund bought $94 million more local notes than they sold last week, Thai Bond Market Association data show.
The yield on the 3.625% debt due June 2023 dropped nine basis points to 4.02%, data compiled by Bloomberg show. The rate was at a two-month high of 4.28% on Nov 25, before the central bank unexpectedly cut its benchmark interest rate by a quarter of a percentage point to 2.25% on Nov 27.
"Thai assets are still attractive as long as the political tension stabilises," said Hideki Hayashi, a researcher at the Japan Center for Economic Research in Tokyo. "If they are relatively cheaper then there should be some demand. The recent performance may be a reflection of this."