Stock Market Reactions to Political Events

May 10, 2012

It is widely accepted that certain businesses and specific sectors of the economy outwardly support one political party or the other.  Presumably, this is because that line of work is expected to thrive particularly under a Democratic or Republican administration, says Jeff Milyo of the Mercatus Center.

Stock market event studies allow for a close analysis of this phenomenon: sudden changes in prices that occur simultaneously with largely unexpected political occurrences can reflect changing perceptions regarding a publicly traded corporation's outlook under a given political climate.

Brian Knight at Brown University exploits the uncertainty in the lead-up to the 2000 election to capture this effect.  Because the race was so hotly contended and its outcome so uncertain, the sudden changes in the stock prices of certain industries can be tracked with great accuracy.

  • Knight constructed portfolios of "Bush-firms" (n=41) and "Gore-firms" (n=29) based on public pronouncements made by several financial analysts offering advice about which firms and industries would be most affected by the election.
  • Knight then used betting odds from the Iowa Electronic Market as a comprehensive daily tracking poll, as it was expected that this metric would incorporate the most immediately available information regarding the likely electoral outcome.
  • Overall, the Bush portfolio of firms was worth 3 percent more after the election and the Gore portfolio about 6 percent less.
  • Thus, the implied value of Bush's victory was equivalent to a transfer of over $100 billion in market capitalization from the firms in the Gore portfolio to those in the Bush portfolio.

Interestingly, Knight also identifies a positive correlation between corporations' soft money political donations and these excess stock market returns.  That is to say, if a given firm stood to benefit from one candidate's victory (presumably any of the 41 or 29 firms mentioned above), it was also likely that they had donated to that candidate's campaign.

This correlation raises important questions about corruption in federal elections and the presence of a quid pro quo relationship.  This is especially true because of the unleashing of corporate dollars for the upcoming election made possible by the invention of Super PACs.

Source: Jeff Milyo, "Stock Market Reactions to Political Events: What Can We Learn about the Efficacy of Political Connections?" Mercatus Center, May 2012.

For text:

http://mercatus.org/sites/default/files/stock-market-reactions-political-events.pdf

 

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