A Risk-based Perspective on the Presidential Puzzle

Abstract

This paper investigates the presidential puzzle (Santa-Clara and Valkanov, 2003) -- the fact that the equity premium is 10% higher in years with Democratic governments than in years with Republican governments. I find the existence of a negative price reaction after Democratic victories in presidential elections. I also establish that the difference in the equity premium is significant only in the first year of the presidential cycle and that there is a negative equity premium in the fourth year of the cycle when the incumbent Republican loses the election. Moreover, the market reaction to changes in the likelihood of a candidate winning the election is significantly different for Republican and Democratic candidates. The evidence is consistent with a risk explanation and policy uncertainty.