DP11864 Political Cycles and Stock Returns

Author(s): Lubos Pástor, Pietro Veronesi
Publication Date: February 2017
Date Revised: October 2018
Keyword(s): political cycles, presidential puzzle, risk aversion
JEL(s): D72, G12, G18, P16
Programme Areas: Public Economics, Financial Economics, Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=11864

We develop a model of political cycles driven by time-varying risk aversion. Heterogeneous agents make two choices: whether to work in the public or private sector and which of two political parties to vote for. In equilibrium, when risk aversion is high, agents elect Democrats---the party promising more redistribution. The model predicts higher average stock market returns under Democratic presidencies, explaining the well-known ``presidential puzzle." The model can also explain why economic growth has been faster under Democratic presidencies. In the data, Democratic voters are more risk-averse. Public workers vote Democrat while entrepreneurs vote Republican, as the model predicts.