Abstract
This study examines whether momentum in stock prices is induced by changes in the political environment. We find that momentum profits are concentrated among politically sensitive firms and industries. During the 1939 to 2011 period, a trading strategy with a long position in winner portfolios (industries or firms) that are politically unfavored and a short position in losers that are politically favored eliminates all momentum profits. Further, our political sensitivity based factor (POL) explains 23-25% (38-40%) of monthly stock (industry) momentum alphas, and generates large increases in time-series R-squared for the momentum factor. This incremental explanatory power is especially strong around Presidential elections when the level of political activity is high. Collectively, our results suggest that investor underreaction to political information generates momentum in stock and industry returns.
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