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Political Sentiment and Predictable Returns

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  • Jawad M. Addoum
  • Alok Kumar

Abstract

This study shows that shifts in political climate influence stock prices. As the party in power changes, there are systematic changes in the industry-level composition of investor portfolios, which weaken arbitrage forces and generate predictable patterns in industry returns. A trading strategy that attempts to exploit demand-based return predictability generates an annualized risk-adjusted performance of 6% during the 1939 to 2011 period. This evidence of predictability spans 17%27% of the market and is stronger during periods of political transition. Our demand-based predictability pattern is distinct from cash flow-based predictability identified in the recent literature.Received November 15, 2013; accepted April 5, 2016 by Editor Andrew Karolyi.

Suggested Citation

  • Jawad M. Addoum & Alok Kumar, 2016. "Political Sentiment and Predictable Returns," Review of Financial Studies, Society for Financial Studies, vol. 29(12), pages 3471-3518.
  • Handle: RePEc:oup:rfinst:v:29:y:2016:i:12:p:3471-3518.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhw066
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    References listed on IDEAS

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    Cited by:

    1. Stefano Ramelli & Alexander F. Wagner & Richard J. Zeckhauser & Alexandre Ziegler, 2018. "Investor Rewards to Climate Responsibility: Evidence from the 2016 Climate Policy Shock," NBER Working Papers 25310, National Bureau of Economic Research, Inc.
    2. Hanke, Michael & Stöckl, Sebastian & Weissensteiner, Alex, 2020. "Political event portfolios," Journal of Banking & Finance, Elsevier, vol. 118(C).
    3. Marshall, Ben R. & Nguyen, Hung T. & Nguyen, Nhut H. & Visaltanachoti, Nuttawat, 2018. "Politics and liquidity," Journal of Financial Markets, Elsevier, vol. 38(C), pages 1-13.
    4. Eichler, Stefan & Plaga, Timo, 2020. "The economic record of the government and sovereign bond and stock returns around national elections," Journal of Banking & Finance, Elsevier, vol. 118(C).
    5. Aabo, Tom & Lee, Suin & Pantzalis, Christos & Park, Jung Chul, 2020. "Know thy neighbor: Political uncertainty and the informational advantage of local institutional investors," Journal of Banking & Finance, Elsevier, vol. 113(C).
    6. Kempf, Elisabeth & Tsoutsoura, Margarita, 2020. "Partisan Professionals: Evidence from Credit Rating Analysts," CEPR Discussion Papers 14343, C.E.P.R. Discussion Papers.
    7. Sunghoon Joo & Dong H. Kim & Jung Chul Park, 2020. "Does local political support influence financial markets? A study on the impact of job approval ratings of political representatives on local stock returns," The Financial Review, Eastern Finance Association, vol. 55(2), pages 247-276, May.
    8. Ramelli, Stefano & Wagner, Alexander F. & Zeckhauser, Richard J. & Ziegler, Alexandre, 2018. "Stock Price Rewards to Climate Saints and Sinners: Evidence from the Trump Election," Working Paper Series rwp18-037, Harvard University, John F. Kennedy School of Government.
    9. Jannati, Sima, 2020. "Geographic spillover of dominant firms’ shocks," Journal of Banking & Finance, Elsevier, vol. 118(C).
    10. Bonaparte, Yosef & Khalaf, Sarah & Korniotis, George, 2019. "Do Role Models Affect Risk-Taking Behavior? The Case of Minorities," CEPR Discussion Papers 14264, C.E.P.R. Discussion Papers.
    11. Nagar, Venky & Schoenfeld, Jordan & Wellman, Laura, 2019. "The effect of economic policy uncertainty on investor information asymmetry and management disclosures," Journal of Accounting and Economics, Elsevier, vol. 67(1), pages 36-57.
    12. Adam L. Aiken & Jesse A. Ellis & Minjeong Kang, 2020. "Do Politicians “Put Their Money Where Their Mouth Is?” Ideology and Portfolio Choice," Management Science, INFORMS, vol. 66(1), pages 376-396, January.
    13. Elisabeth Kempf & Margarita Tsoutsoura, 2018. "Partisan Professionals: Evidence from Credit Rating Analysts," NBER Working Papers 25292, National Bureau of Economic Research, Inc.
    14. Moszoro, Marian, 2020. "Political Cognitive Biases Effects on Fund Managers' Performance," MPRA Paper 101572, University Library of Munich, Germany.
    15. Angelini, Eliana & Foglia, Matteo & Ortolano, Alessandra & Leone, Maria, 2018. "The “Donald” and the market: Is there a cointegration?," Research in International Business and Finance, Elsevier, vol. 45(C), pages 30-37.

    More about this item

    JEL classification:

    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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