NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Electoral Outcomes and Financial Markets

"In 2000, 2004, and over the entire 1880-2004 period, a Republican victory raised equity values by about 2 percent. On the other hand, since the Reagan Administration, Republican victories also have raised interest rates on government bonds by about 0.12 percent."

The economy has a significant impact on the outcome of elections. However, it is not known whether elections affect the economy. Some observers maintain that candidates and parties tend to converge to the same economic policies - those of the median voter - so that who wins an election is inconsequential to the economy. Others believe that political parties promote discrete economic expectations, and that the election of a Democrat or a Republican candidate for president will have substantially different - and predictable - influences on markets.

To date, evidence supporting either view has been difficult to isolate. But in Partisan Impacts on the Economy: Evidence from Prediction Markets and Close Elections (NBER Working Paper No. 12073), co-authors Erik Snowberg, Justin Wolfers, and Eric Zitzewitz weigh in on this contentious matter with a novel analysis of data from financial and prediction markets. They perform an in-depth analysis of the 2000 and 2004 U.S. presidential elections and then extend their analysis to presidential contests as far back as 1880. They find that in 2000, 2004, and over the entire 1880-2004 period, a Republican victory raised equity values by about 2 percent. On the other hand, since the Reagan Administration, Republican victories also have raised interest rates on government bonds by about 0.12 percent.

The researchers reach these conclusions by examining the movement of financial markets as votes are counted on Election Day. For the 2004 election, they pair data for equity index and other futures with a liquid prediction market, run by Tradesports.com, which tracked the election outcome. The TradeSports.com contract would pay $10 if Bush were re-elected and nothing if he lost. The price of this contract (multiplied by 10) can be interpreted as Bush's probability of winning. Snowberg, Wolfers, and Zitzewitz match data from this contract with the price of the last transaction in the same ten-minute window for the December 2004 futures contracts of several financial variables: the S&P 500, Dow Jones and Nasdaq 100 indices, currency futures, two- and 10-year Treasury Note futures, and several oil futures.

They find that financial prices closely tracked the election news during Election Day. Leaked exit polls favoring Kerry released at around 4 p.m. provide a sharp natural experiment; they were accompanied by stock price declines and bond price increases, and these movements were reversed when Bush emerged as the winner later in the evening. From these movements, the authors conclude that markets expected the S&P 500 to be worth 1.6 percent more under a Bush Presidency, but also expected 10-year bond yields to be 0.11 percent higher.

This analysis clearly demonstrates that political shocks were expected to cause economic changes. However, from examining the 2004 election alone one cannot distinguish whether the estimated effects are caused by the election of a Republican (indicating perceived partisan policy effects) or the re-election of the President (suggesting the perceived benefits of an incumbent). This leads the researchers to turn to the 2000 election, in which there was no incumbent running.

In 2000 the major financial indicators moved sharply when expectations of a Bush victory changed -- much as they did in 2004. The researchers note that there were no prediction markets to track the probability of either candidate's victory during election night, 2000. However Centrebet, an Australian bookmaker, ran a contract that closed on the morning of the election, showing a 60 percent chance of a Bush victory.

The researchers reasoned that when Florida was called for Gore, Bush's probability of victory could not have dropped more than 60 percent. This, paired with various futures contracts, allowed them to determine that a Bush victory in 2000 was expected to lead to at least a 1.3 percent increase in the S&P 500, and a 0.6 percent appreciation of the dollar. After Florida was moved back to the undecided column, the prices of all the economic indicators reverted to their original levels. When Florida was later called for Bush, the researchers assume no more than a 40 percent increase in the chance of a Bush victory, yielding lower bounds of Bush's effect on the above economic indicators of 1.9 percent, and 0.7 percent respectively. These estimates are consistent with the researchers' findings for the 2004 elections, so they conclude that it was the differences between Bush and his Democratic opponents that drove the market's reaction, rather than Bush's status as an incumbent in 2004.

To study earlier elections, the researchers compared stock market returns from the pre-election close to the post-election close. Their innovation is to complement this data with election betting that dates back to 1880. They find that equity markets rose when Republican presidential candidates were elected. Significantly, the more surprising the Republican victory, the more markets rose. Surprising Democratic victories were likewise accompanied by market declines.

Snowberg, Wolfers, and Zitzewitz conclude that changes in the perceived probability of electing a Republican president caused changes in expected bond yields, equity returns, and oil prices. The authors conjecture that the 2-3 percent jump in equity prices accompanying a Bush victory could be attributable to expectations of capital receiving favored treatment over labor, of existing firms receiving favorable treatment over potential entrants, or of general economic expansion under the Bush administration. That long bond yields were expected to rise under Bush is inconsistent with the traditional perception of Republicans as fiscally conservative, but consistent with the higher deficits created under Republicans since the 1980s.

The researchers caution that the sign of partisan effects on equity prices and economic well being need not be the same. Furthermore, their analysis captures traders' expectations of partisan effects, not the parties' actual effects on economic outcomes

-- Matt Nesvisky

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