Political Sentiment and Predictable Returns
72 Pages Posted: 2 Nov 2012 Last revised: 1 Mar 2016
Date Written: February 29, 2016
This study shows that shifts in political climate influence stock prices. As the party in power changes, there are systematic changes in the industry-level composition of investor portfolios, which weaken arbitrage forces and generate predictable patterns in industry returns. A trading strategy that attempts to exploit demand-based return predictability generates an annualized risk-adjusted performance of six percent during the 1939 to 2011 period. This evidence of predictability spans 17-27% of the market and is stronger during periods of political transition. Our demand-based predictability pattern is distinct from cash-flow based predictability identified in the recent literature.
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