Abstract
AbstractUsing microlevel panel data and a difference-in-differences identification strategy, we study the effect of political uncertainty on household stock market participation. We find that households significantly reduce their participation and reallocate funds to safer assets during periods of increased political uncertainty prior to gubernatorial elections. The decline in participation is related to households’ response to elevated asset risk and their incentive to hedge increased labor income risk. In situations where uncertainty remains high after elections, pre-election reduction in participation is only partially reversed.
Highlights
Political uncertainty is related to the range, likelihood, and impact of future government actions.The magnitude of uncertainty depends on what policy actions will be undertaken, who will make these decisions, and to what extent the policies will be implemented
We develop a simple theoretical model to illustrate that political uncertainty affects household stock market participation through two channels that are distinct from the real option channel for corporate investments
We do not provide an explanation for the overall low participation of households (e.g., Campbell 2006), we show that political uncertainty can exacerbate this phenomenon by inducing households to reduce their stock investments prior to elections
Summary
Political uncertainty is related to the range, likelihood, and impact of future government actions. When examining the interaction effects between elections and exposures to asset risk and labor income risk, we utilize joint state–year fixed effects in a triple difference setting This framework controls for the impact of latent state-level shocks or trends and helps us understand the mechanisms driving the effect of political uncertainty on household stock market participation. Our theoretical model predicts that aversion to asset risk and the need to hedge labor income risk can cause households to reduce stock investments when they face greater political uncertainty prior to gubernatorial elections. Analyzing the different combinations of in-state and out-of-state households and firms enables us to test the effects of asset risk and labor income risk separately, and, thereby, identify the channels through which gubernatorial elections affect stock market participation. 51% are female, 53% are married, and the average age is 46.9 years
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