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Stock Market Returns and Partisan Political Business Cycles

  • James Cooley

    ()

    (Southern Methodist University)

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    Excess returns in the stock market are significantly higher during Democratic presidential administrations. Previous research concludes that partisan return differentials are anomalous since they are not due to differences in required returns. We find that partisan return differentials are, instead, likely due to differences in cash flows - capital income growth - during the first years of presidential administrations as predicted by the rational partisan model of the business cycle. The first major finding of this paper is that there is a statistically and economically significant partisan difference in capital income growth in the first year of presidential terms. The second finding of the paper is that significant partisan differences in excess returns are also found only in the first year of presidential terms. Further, it is differences in unexpected returns during that first year that is the source of partisan return differentials. We find no statistically significant partisan differences in unexpected returns during the rest of the term. This result holds across market capitalization deciles and book-to-market value deciles. The third finding is that there is a positive and statistically significant relationship between unexpected returns and capital income growth and real GDP growth one and two quarters ahead. Lastly, we find that the unexpected returns are related to the degree of electoral surprise as predicted by the rational partisan model. We conclude that that there is strong evidence in favor of the rational partisan model as an explanation for partisan return differences in the stock and bond markets.

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    File URL: ftp://ftp1.economics.smu.edu/WorkingPapers/2009/COOLEY/COOLEY-2009-04.pdf
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    Paper provided by Southern Methodist University, Department of Economics in its series Departmental Working Papers with number 0902.

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    Date of creation: Apr 2009
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    Handle: RePEc:smu:ecowpa:0902
    Contact details of provider: Postal: Department of Economics, P.O. Box 750496, Southern Methodist University, Dallas, TX 75275-0496
    Phone: 214-768-2715
    Fax: 214-768-1821
    Web page: http://www.smu.edu/economics

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    1. John Y. Campbell, 1990. "A Variance Decomposition for Stock Returns," NBER Working Papers 3246, National Bureau of Economic Research, Inc.
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    4. Ellen R. McGrattan & Edward C. Prescott, 2003. "Average Debt and Equity Returns: Puzzling?," Levine's Working Paper Archive 506439000000000367, David K. Levine.
    5. Campbell, John & Shiller, Robert, 1988. "Stock Prices, Earnings, and Expected Dividends," Scholarly Articles 3224293, Harvard University Department of Economics.
    6. Fama, Eugene F, 1991. " Efficient Capital Markets: II," Journal of Finance, American Finance Association, vol. 46(5), pages 1575-617, December.
    7. Alesina, Alberto, 1987. "Macroeconomic Policy in a Two-party System as a Repeated Game," Scholarly Articles 4552531, Harvard University Department of Economics.
    8. Whitney K. Newey & Kenneth D. West, 1986. "A Simple, Positive Semi-Definite, Heteroskedasticity and AutocorrelationConsistent Covariance Matrix," NBER Technical Working Papers 0055, National Bureau of Economic Research, Inc.
    9. 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.
    10. 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.
    11. Michael Berlemann & Gunther Markwardt, 2007. "Unemployment and Inflation Consequences of Unexpected Election Results," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(8), pages 1919-1945, December.
    12. Hibbs, Douglas Jr., 1992. "Partisan theory after fifteen years," European Journal of Political Economy, Elsevier, vol. 8(3), pages 361-373, October.
    13. Douglas A. Hibbs, 1994. "The Partisan Model Of Macroeconomic Cycles: More Theory And Evidence For The United States," Economics and Politics, Wiley Blackwell, vol. 6(1), pages 1-23, 03.
    14. 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.
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