Politics and Stock Returns: A Rationalization

Abstract

In this study, we find some evidence in favor of systematic risk being priced in the cross-section of stock returns when the effects of presidential cycles and political environments are taken into account. During Democratic presidencies or harmonious political environments, beta has a positive relation to stock returns, but is negatively related to returns during Republican presidencies or in gridlock periods. We find that both the presidential puzzle and the harmony premium can be rationalized when the effects of politics on the beta-return relation are taken into account.