Partisan Conflict, News, and Investors' Expectations

Abstract

AbstractI consider the role of news provided by the media as signals used by investors to learn about partisan conflict. Higher partisan conflict induces uncertainty (by increasing the probability of crises) and gridlock (making tax reforms less likely), both affecting investment returns. The true degree of political disagreement is unobservable to investors, who create expectations based on the observation of informative signals. Using a Bayesian learning model, I illustrate how these signals affect investment decisions. To the extent crises are severe enough, an increase in the partisan conflict reduces expected returns and induces lower investment.