Political Cycles and Stock Prices

Descripition of the project

We often hear that politics affect the economy—but 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—like individual companies and their stocks?

This research project explores how political cycles—specifically the shift between Republican and Democratic presidencies in the US—affect 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—and 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—potentially leading to stronger and more prolonged price drifts.

We’re also looking at how expectations around tax policy might affect investor behavior. A company’s value can change dramatically depending on how much tax it’s expected to pay in the future. If investors aren’t sure how tax rules will change—or misjudge them entirely—they 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—not 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.