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Washington meets Wall Street: A Closer Examination of the Presidential Cycle Puzzle

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Author Info
R. Kraeussl () (VU University Amsterdam)
A. Lucas () (VU University Amsterdam)
D. Rijsbergen () (VU University Amsterdam)
P.J. van der Sluis (VU University Amsterdam)
E. Vrugt (APG Investments)

Additional information is available for the following registered author(s):

Abstract

This paper tests the policitcal dimensions of the presidential cycle effect in U.S. financial markets. The presidential cycle effect states that average stock market returns are significantly higher in the last two years compared to the first two years of a presidential term. We confirm the robust existence of this cycle in U.S. stock markets as well as bond markets. As most rational theories to explain the cycle were falsified by earlier empirical work, this paper sets out to test the presidential cycle election (PCE) theory as an alternative explanation. The PCE theory states that incumbent parties and presidents have an incentive to manipulate the economy (via budget expansions, taxes, etc.) to remain in power. We formulate seven different propositions relating to fiscal, monetary, tax, and political implications of PCE theory. We find no statistically significant evidence confirming the PCE theory as a plausible explanation for the presidential cycle effect. The existence of the presidential cycle effect in U.S. financial markets thus remains a puzzle that cannot be easily explained by politicians mis-using their economic influence to remain in power.

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Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 08-101/2.

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Date of creation: 23 Oct 2008
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Handle: RePEc:dgr:uvatin:20080101

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Related research
Keywords: political economy; inefficient markets; market anomalies; calendar effects;

Find related papers by JEL classification:
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
P16 - Economic Systems - - Capitalist Systems - - - Political Economy of Capitalism
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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  2. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July. [Downloadable!] (restricted)
  3. Haynes, Stephen E & Stone, Joe A, 1989. "An Integrated Test for Electoral Cycles in the U.S. Economy," The Review of Economics and Statistics, MIT Press, vol. 71(3), pages 426-34, August. [Downloadable!] (restricted)
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  6. Gartner, Manfred & Wellershoff, Klaus W., 1995. "Is there an election cycle in American stock returns?," International Review of Economics & Finance, Elsevier, vol. 4(4), pages 387-410. [Downloadable!] (restricted)
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  12. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May. [Downloadable!] (restricted)
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  13. Campbell, John Y, 1991. "A Variance Decomposition for Stock Returns," Economic Journal, Royal Economic Society, vol. 101(405), pages 157-79, March. [Downloadable!] (restricted)
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  14. Pedro Santa-Clara & Rossen Valkanov, 2003. "The Presidential Puzzle: Political Cycles and the Stock Market," Journal of Finance, American Finance Association, vol. 58(5), pages 1841-1872, October. [Downloadable!] (restricted)
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