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

Posted: 23 Jan 2017

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 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

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=2959164 or http://dx.doi.org/10.2139/ssrn.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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