Political Cycles and Stock Prices
Short description
How do political cycles affect stock prices鈥攏ot just overall markets, but individual firms? This project explores how shifts between Republican and Democratic presidents influence stock returns, especially around earnings announcements. The findings could help explain investor behavior and market dynamics.
Descripition of the project
We often hear that politics affect the economy鈥攂ut just how deep does that influence go? Economists have long known that shifts in political power, like a change from a Democratic to a Republican president, can steer big-picture economic trends. But what about the smaller gears in the machine鈥攍ike individual companies and their stocks?
This research project explores how political cycles鈥攕pecifically the shift between Republican and Democratic presidencies in the US鈥攁ffect stock market outcomes. Previous research has explored variations in macroeconomic outcomes, including the returns on the aggregate stock market, across political cycles (e.g., Santa-Clara and Valkanov, 2003; Blinder and Watson, 2016). However, there is little prior work on the potential effects on individual firm-level outcomes and stock returns. It is reasonable to expect that the economic impact of political cycles extends beyond the overall macroeconomic performance and that a regime change may have differing impacts across differing firms.
One key event we focus on is when companies announce their earnings. These announcements are a big deal: they tell investors how well a company is doing and often lead to large changes in its stock prices. According to the efficient market hypothesis, stock prices should instantly reflect this new information. However, a well-documented puzzle in the literature is that prices often continue to drift in the direction of earnings news for one or two months after the announcement, a phenomenon known as Post-Earnings Announcement Drift (PEAD). This implies that the information contained in the earnings news is only gradually incorporated into stock prices, which is a clear deviation from the Efficient Market Hypothesis. In fact, it is considered as one of the most significant challenges to the efficient market hypothesis.
Our research explores whether this price drift behaves differently depending on which political party is in the White House鈥攁nd if so, why. For example, the recent tariff turmoil has made certain firms more vulnerable to trade policy uncertainty under the Trump administration. This type of heightened uncertainty, which has appeared frequently throughout history, may cause investors to delay acting on new earnings news鈥攑otentially leading to stronger and more prolonged price drifts.
We鈥檙e also looking at how expectations around tax policy might affect investor behavior. A company鈥檚 value can change dramatically depending on how much tax it鈥檚 expected to pay in the future. If investors aren鈥檛 sure how tax rules will change鈥攐r misjudge them entirely鈥攖hey might delay reacting to new financial information as well.
By studying these dynamics, our research hopes to offer new insights into how politics shape financial markets鈥攏ot just at the aggregate level, but down to the level of individual companies. These findings could help both investors and policymakers better understand the real economic effects of political cycles.