Political Uncertainty and Institutional Herding

Abstract

Political uncertainty represents a key determinant of investment decisions. In this paper, we explore whether institutional investors herd in response to political uncertainty, and affect stock prices in the process. Using U.S. equity holdings data from 13F filings, we find evidence consistent with these predictions. The herding response is especially strong when U.S. presidents are unpopular, due to their proclivity for controversial policies, and among riskier stocks. We also find that this mechanism helps impound a risk premium into stock prices, thus improving market efficiency. Overall, the findings unveil a new channel through which political uncertainty affects financial markets.

Keywords: Herding, institutional investors, political uncertainty, presidential popularity.

JEL Classification: G11, G18, G23.