Economic policy and the presidential election cycle in stock returns

Abstract

Many papers in the academic literature have documented a “Presidential Election” cycle in stock returns. Prior literature also documents that stock returns appear to be influenced by economic policy. The goal of this study is to examine the tools of fiscal and monetary policy to test for the presence of a presidential election cycle. The findings strongly suggest that the presidential election cycle in stock returns and the government’s economic policy influence on stock returns are two separate phenomena. Moreover, it is much more likely that stock returns are influencing economic policy rather than the other way around. However, the findings also suggest that tax legislation may drive the Presidential Election Cycle.

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Notes

  1. 1.

    Other studies have searched for a PEC in markets outside of the U.S. For example, Dopke and Pierdzioch (2006) find no evidence of a PEC in German stock returns. In addition, Gartner (1994) takes issue with the work of Alesina (1987) arguing that left (right) of center parties raise (lower) the level of real activity and inflation permanently. Gartner (1994) also provides a brief, but excellent, literature review of the major papers in this line of research.

  2. 2.

    A similar line of research that documents a “Presidential Cycle” refers to the difference in stock market returns under Republican versus Democratic presidencies. The seminal paper in this line was Santa-Clara and Valkanov (2003) who find excess returns under Democratic presidents.

  3. 3.

    A phenomenon known as the “Other” January Effect. For other excellent papers related to the PEC, see Nordhaus (1975), Gartner and Wellershoff (1995), Li and Born (2006) and others.

  4. 4.

    1972 is chosen as the first year because it is the first year available for the fed funds rate used later in the study. Therefore, all data collection starts with 1972 in order to align all of the time series.

  5. 5.

    The only surplus years in this sample occurred during the period 1998–2001.

  6. 6.

    The exact proportion is 36.11%, results not reported. This value is used for the test proportion in the remaining years.

  7. 7.

    Fiscal policy is chosen because it is the most likely source of the PEC in stock returns. See Drazen (2001) and others.

  8. 8.

    I would like to thank an anonymous reviewer for making this point.

  9. 9.

    Laws not likely to have a major impact on the economy, such as the Taxpayer Bill of Rights Act 2 of 1996, were omitted.

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Correspondence to Ray R. Sturm.

Additional information

I gratefully acknowledge the very helpful comments from and discussions with Drew B. Winters, participants at the 2009 Financial Management Association’s annual conference, Stuart Michelson and two anonymous referees.

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Sturm, R.R. Economic policy and the presidential election cycle in stock returns. J Econ Finan 37, 200–215 (2013). https://doi.org/10.1007/s12197-011-9179-6

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Keywords

  • Stock Returns
  • President
  • Election Cycle
  • Economic Policy
  • Tax Legislation