Equity Premiums in the Presidential Cycle: the Midterm Election Resolution of Uncertainty

79 Pages Posted: 23 Jan 2017 Last revised: 26 Apr 2018

See all articles by Kam Fong Chan

Kam Fong Chan

The University of Western Australia; Financial Research Network (FIRN)

Terry Marsh

Quantal International Inc.

Date Written: April 16, 2018

Abstract

We analyze shifts in political uncertainty and equity premiums over the U.S. Presidential election cycle. Somewhat ironically, it is midterm elections that turn out to be associated with the highest pre-election increases in uncertainty, leading to higher equity premiums post-midterm as the policy uncertainty and ex ante risk premiums decrease. We show this to have been the case for federal elections held over the past two centuries. We argue that the political uncertainty, which we measure primarily by the Economic Policy Uncertainty index, tends to be a tail risk that has previously been found to be compensated by higher premiums. We also find that the “lost CAPM” for expected equity returns reappears to fit returns amidst the post-midterm flood of public information, but not at other times in the Presidential cycle. We further show that the idiosyncratic volatility and lottery-demand puzzles disappear in post-midterm months.

Keywords: Political uncertainty; Midterm election; Presidential cycle; Lost CAPM; Idiosyncratic volatility

JEL Classification: E5; G11; G14

Suggested Citation

Chan, Kam Fong and Marsh, Terry, Equity Premiums in the Presidential Cycle: the Midterm Election Resolution of Uncertainty (April 16, 2018). Available at SSRN: https://ssrn.com/abstract=2903067

Kam Fong Chan (Contact Author)

The University of Western Australia ( email )

35 Stirling Highway
Crawley, Western Australia 6009
Australia

Financial Research Network (FIRN) ( email )

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

Terry Marsh

Quantal International Inc. ( email )

Two Embarcadero Center
8th Floor
San Francisco, CA 94111
United States
415-744-5301 (Phone)

HOME PAGE: http://www.quantal.com

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