NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Political Cycles and Stock Returns

Lubos Pastor, Pietro Veronesi

NBER Working Paper No. 23184
Issued in February 2017, Revised in October 2018
NBER Program(s):Asset Pricing, Economic Fluctuations and Growth, Political Economy

We develop a model of political cycles driven by time-varying risk aversion. Heterogeneous agents make two choices: whether to work in the public or private sector and which of two political parties to vote for. In equilibrium, when risk aversion is high, agents elect Democrats—the party promising more redistribution. The model predicts higher average stock market returns under Democratic presidencies, explaining the well-known “presidential puzzle.” The model can also explain why economic growth has been faster under Democratic presidencies. In the data, Democratic voters are more risk-averse. Public workers vote Democrat while entrepreneurs vote Republican, as the model predicts.

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Document Object Identifier (DOI): 10.3386/w23184

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