Government Spending, Political Cycles and the Cross Section of Stock Returns

Abstract:     
Using a novel measure of industry exposure to government spending, we document predictable variation in cash flows and stock returns over political cycles. During Democratic presidencies, firms with high government exposure experience higher cash flows and stock returns, while the opposite pattern holds true during Republican presidencies. Business cycles, firm characteristics, and standard risk factors do not account for the pattern in returns across presidencies. An investment strategy that exploits the presidential cycle predictability generates abnormal returns as large as 6.9 percent per annum. Our results suggest market under reaction to predictable variation in the effect of government spending policies.

Number of Pages in PDF File: 54

Keywords: Cross-Sectional Asset Pricing, Government Spending, Political Cycles, Input-Output Analysis.

JEL Classification: D57, E6, G18, G12, H50

working papers series