Washington meets Wall Street: A closer examination of the presidential cycle puzzle

• Published in: Journal of international money and finance Vol. 43; pp. 50 - 69
• Main Authors: Kräussl, Roman, Lucas, André, Rijsbergen, David R., van der Sluis, Pieter Jelle, Vrugt, Evert B.
• Format: Journal Article
• Language: English
• Published: Kidlington Elsevier Ltd 01.05.2014; Elsevier Science Ltd
• Subjects: Anomalies; Business cycles; Calendar effects; Candidates; Capital market; Hypotheses; Inflation; International finance; Investment analysis; Market efficiency; Monetary economics; Personal finance; Political economy; Political power; Presidential cycle; Presidential elections; Risk premiums; Securities markets; Studies; U.S.A; United States > US; Calendar effects; P16; E32; Presidential cycle; Market efficiency; G14; Political economy; Anomalies
• ISSN: 0261-5606; 1873-0639
• DOI: 10.1016/j.jimonfin.2013.11.003

We show that the annual excess return of the S&P 500 is almost 10 percent higher during the last two years of the presidential cycle than during the first two years. This pattern cannot be explained by business-cycle variables capturing time-varying risk premia, differences in risk levels, or by consumer and investor sentiment. We formally test the presidential election cycle (PEC) hypothesis as an alternative to explain the presidential cycle anomaly. The PEC states that incumbent parties and presidents have an incentive to manipulate the economy (via budget expansions and taxes) to remain in power. We formulate eight testable propositions relating to the fiscal, monetary, tax, unexpected inflation and political implications of the PEC hypothesis. We do not find statistically significant evidence confirming the PEC hypothesis as a plausible explanation for the presidential cycle effect. The presidential cycle effect in U.S. financial markets thus remains a puzzle that cannot be easily explained by politicians employing their economic influence to remain in power, as is often believed. •Stock market returns are almost 10 percent higher during the last 2 years of a presidential term.•These returns cannot be explained by business cycle variables, risk, or sentiment.•We examine whether the returns result from politicians using their economic influence to remain in power.•We find no empirical evidence for this looking at fiscal, monetary, tax, and political implications.•The presidential cycle thus remains a puzzle.