The calming effects of conflict: The impact of partisan conflict on market volatility

Abstract

In recent decades, an increasing divide in political ideologies between Republicans and Democrats has had a notable impact on financial markets. In this paper, we investigate the effect of political conflict, as measured by the partisan conflict index (PCI), on both market and industry-level volatility. We find that PCI has a significant negative impact on market volatility, robust to different regression models. We provide evidence that such impact is not driven by dramatic political events, namely wars and presidential elections, or by presidential party. When controlling for market cycles, we show that PCI reduces volatility during expansionary periods but increases volatility during recessions. Furthermore, at the industry level, we find that PCI decreases volatility overall. We also find that PCI decreases the volatility of politically-sensitive industries significantly more that it does with other industries. These results can inform government policy makers, analysts, investors, and academics alike.