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

54 Pages Posted: 19 Mar 2010 Last revised: 10 Oct 2011

See all articles by Frederico Belo

Frederico Belo

University of Minnesota; INSEAD; National Bureau of Economic Research (NBER)

Vito Gala

The Wharton School, University of Pennsylvania

Jun Li

University of Texas at Dallas

Date Written: October 9, 2011

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.

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

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

Suggested Citation

Belo, Frederico and Gala, Vito and Li, Jun, Government Spending, Political Cycles and the Cross Section of Stock Returns (October 9, 2011). Available at SSRN: https://ssrn.com/abstract=1572801 or http://dx.doi.org/10.2139/ssrn.1572801

Frederico Belo (Contact Author)

University of Minnesota ( email )

19th Avenue South
Minneapolis, MN 55455
United States

INSEAD ( email )

Boulevard de Constance
77305 Fontainebleau Cedex
France

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Vito Gala

The Wharton School, University of Pennsylvania ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

Jun Li

University of Texas at Dallas ( email )

800 West Campbell Road, SM 31
Richardson, TX 75080
United States
972-883-4422 (Phone)

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