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Political Cycles and the Stock Market

  • Santa-Clara, Pedro
  • Valkanov, Rossen
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    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 qt00n6f3ph.

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    Date of creation: 01 Jun 2000
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    Handle: RePEc:cdl:anderf:qt00n6f3ph
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    1. Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, vol. 22(1), pages 3-25, October.
    2. Keim, Donald B. & Stambaugh, Robert F., 1986. "Predicting returns in the stock and bond markets," Journal of Financial Economics, Elsevier, vol. 17(2), pages 357-390, December.
    3. 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.
    4. Roger Koenker, 2000. "Inference on the Quantile Regression Process," Econometric Society World Congress 2000 Contributed Papers 0886, Econometric Society.
    5. Jon Faust & John Irons, 1996. "Money, politics and the post-war business cycle," International Finance Discussion Papers 572, Board of Governors of the Federal Reserve System (U.S.).
    6. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," The Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July.
    7. Fama, Eugene F. & French, Kenneth R., 1997. "Industry costs of equity," Journal of Financial Economics, Elsevier, vol. 43(2), pages 153-193, February.
    8. Alesina, Alberto, 1987. "Macroeconomic Policy in a Two-party System as a Repeated Game," Scholarly Articles 4552531, Harvard University Department of Economics.
    9. Faust, Jon & Irons, John S., 1999. "Money, politics and the post-war business cycle," Journal of Monetary Economics, Elsevier, vol. 43(1), pages 61-89, February.
    10. John Y. Campbell, 1990. "A Variance Decomposition for Stock Returns," NBER Working Papers 3246, National Bureau of Economic Research, Inc.
    11. Alberto Alesina & Nouriel Roubini & Gerald D. Cohen, 1997. "Political Cycles and the Macroeconomy," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262510944, June.
    12. David H. Cutler & James M. Poterba & Lawrence H. Summers, 1988. "What Moves Stock Prices?," Working papers 487, Massachusetts Institute of Technology (MIT), Department of Economics.
    13. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
    14. Hodrick, Robert J, 1992. "Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement," Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 357-86.
    15. Nordhaus, William D, 1975. "The Political Business Cycle," Review of Economic Studies, Wiley Blackwell, vol. 42(2), pages 169-90, April.
    16. Fama, Eugene F, 1991. " Efficient Capital Markets: II," Journal of Finance, American Finance Association, vol. 46(5), pages 1575-617, December.
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