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Political Cycles and the Stock Market

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Author Info
Pedro Santa-Clara (Anderson School of Management)
Rossen Valkanov (Anderson School of Management)
Abstract

We find that the average excess return in the stock market is higher under Democratic than Republican presidents a difference of 9 percent per year for the value-weighted portfolio and 16 percent for the equal-weighted portfolio. The difference is economically and statistically significant, does not seem to be due to small sample biases, and is robust in different subsamples. There is a remarkable monotonicity in the difference of returns for size-decile portfolios, from 7 percent for large firms to about 22 percent for small firms. Presidential partisan cycles have a heterogeneous impact on industry returns: the tobacco, telecom, and chemical industries have performed better under Republican presidents, whereas the real estate, construction, and services industries have fared significantly better under Democrats. We test three plausible explanations for these findings. First, the relation might be due to political variables proxying for business-cycle factors. Second, the relation might be attributed to unexpected returns around elections, when information is revealed, rather than to expected returns varying with the political cycle. Lastly, differences in stock market riskiness across presidential regimes could account for the difference in average returns. We reject all three hypotheses. As it stands, the difference in excess returns during Republican and Democratic presidencies is a puzzle that cannot easily be explained. However, the cross-sectional evidence from size-sorted and industry portfolios suggests that the party in the presidency may affect the stock market through differences in fiscal and regulatory policies.

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Paper provided by Anderson Graduate School of Management, UCLA in its series University of California at Los Angeles, Anderson Graduate School of Management with number 1074.

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Date of creation: 01 Jun 2000
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  4. French, Kenneth R. & Schwert, G. William & Stambaugh, Robert F., 1987. "Expected stock returns and volatility," Journal of Financial Economics, Elsevier, vol. 19(1), pages 3-29, September. [Downloadable!] (restricted)
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  7. Geske, Robert & Roll, Richard, 1983. " The Fiscal and Monetary Linkage between Stock Returns and Inflation," Journal of Finance, American Finance Association, vol. 38(1), pages 1-33, March. [Downloadable!] (restricted)
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  19. Roger Koenker & Kevin F. Hallock, 2001. "Quantile Regression," Journal of Economic Perspectives, American Economic Association, vol. 15(4), pages 143-156, Fall. [Downloadable!] (restricted)
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