ThePresidentialPuzzle:PoliticalCyclesandthe StockMarket PEDRO SANTA-CLARA and ROSSEN VALKANOV n ABSTRACT TheexcessreturninthestockmarketishigherunderDemocraticthanRepub- lican presidencies: 9 percent for the value-weighted and 16 percent for the equal-weightedportfolio.The di¡erence comes from higher real stock returns and lower real interest rates, is statistically signi¢cant, and is robust in sub- samples.The di¡erencein returns is notexplainedbybusiness-cyclevariables related to expected returns, and is not concentrated around election dates. Thereis no di¡erenceintheriskiness of the stock market acrosspresidencies that could justify a risk premium. The di¡erence in returns through the politicalcycle is therefore a puzzle. INTHERUN-UPTOALLPRESIDENTIALELECTIONS,thepopularpressisawashwithreports aboutwhetherRepublicans orDemocrats arebetter for the stock market. Unfor- tunately, the popular interest has not been matched by academic research.This paper ¢lls that gap by conducting a careful empirical analysis of the relation betweenpresidentialelections and the
stock market. Using data since 1927, we ¢nd that the average excess return of the value- weighted CRSP index over the three-monthTreasury bill rate has been about 2 percentunder Republican and11percent underDemocraticpresidentsFa strik- ing di¡erence of 9 percent per year! This di¡erence is economicallyand statisti- callysigni¢cant. Adecompositionofexcess returns reveals that the di¡erence is duetorealmarketreturnsbeinghigherunderDemocratsbymorethan5percent, as well as to real interest rates being almost 4 percent lower under Democrats. Theresults areeven moreimpressive for the equal-weightedportfolio, wherethe di¡erencein excess returnsbetweenRepublicans and Democrats reaches16per- cent. Moreover, we observe an absolute monotonicity in the di¡erence between size-decile portfolios under the twopolitical regimes: From 7 percent for the lar- gest ¢rms to about 22 percent for the smallest ¢rms. THE JOURNAL OF FINANCE C15 VOL. LVIII, NO. 5 C15 OCTOBER 2003 n Santa-Clara and Valkanov are from The Anderson School, University of California, Los Angeles. We thank Antonio Bernardo, Michael Brandt, Michael Brennan, Bhagwan Chowdhry, Brad Cornell, Eugene Fama, Shingo Goto, Mark Grinblatt, Harrison Hong, Jun Liu, Francis Longsta¡, Monika Piazzesi, Richard Roll, and Jose¤ Tavares for useful comments. We are especially grateful to Maria Gonzalez, Richard Green (the editor), and an anonymous referee for many suggestions that have greatly improved this paper.We thank Kenneth French and G.William Schwert for providing ¢nancial data. All remaining errors are our own. 1841 When faced with a result such as this, we have to ask ourselves whether the ¢ndings are spurious.We conduct several robustness checks, including studying di¡erent subsamples, correcting the statistical inference for short-sample pro- blems,andexaminingtheimpactofoutliers.In subsamples,therelationbetween excess returns and the politicalvariables remains signi¢cant. However, thelevel of signi¢cance drops from 5 to 10 percent, largelybecause the power of our tests decreases substantially with the number ofelections.We run abootstrap experi- ment to correct small-sample inference problems.The corrected statistics corro- borate the signi¢cance of the relation between political cycles and the equity premium. Finally, we use quantile regressions to establish that outliers do not drive our results. Of course, given the limitations of the data, we can never be absolutelysure that the impact of political cycles on the stock market is not just a statistical £uke. We examinewhether the di¡erence in average returns is due to a di¡erence in expected returns oradi¡erenceinunexpected returns. Inthe ¢rst case, the di¡er- ence in realized returns would be due to a‘‘Democratic risk premium.’’ 1 In the secondcase,the di¡erenceinreturnswouldbe drivenbysurprisesintheeconom- ic policies of the party in the presidency. In other words, a di¡erence in...
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