Equity Premiums in the Presidential Cycle: the Midterm Election Resolution of Uncertainty
Posted: 23 Jan 2017
Date Written: April 16, 2018
We analyze shifts in political uncertainty and equity premiums over the U.S. Presidential cycle for the last 150 years. Interestingly, it is the midterms that are associated with the highest pre-election increases in political uncertainty, leading to higher realized equity premiums post-midterm as political uncertainty is resolved and ex-ante risk premiums decrease. The higher realized equity premium in post-midterm periods is also accompanied by positive real investment and economic growth. We also find that the “lost CAPM”, idiosyncratic volatility and lottery-demand puzzles all disappear in post-midterm months. Furthermore, we show that a strategy that buys midterm sensitive stocks and shorts midterm insensitive stocks prior to the midterms earns on average 1.20% monthly return over the subsequent six months. Overall, our results are consistent with the hypothesis that ex-ante political uncertainty diminishes following elections, leading to higher ex-post return premiums.
Keywords: Political uncertainty; Midterm election; Lost CAPM; Idiosyncratic volatility
JEL Classification: D81; G11; G12; G14
Suggested Citation: Suggested Citation