Equity Premiums in the Presidential Cycle: the Midterm Election Resolution of Uncertainty


We analyze shifts in political uncertainty and equity premiums over the U.S. Presidential election cycle. Somewhat ironically, it is midterm elections that turn out to be associated with the highest pre-election increases in uncertainty, leading to higher equity premiums post-midterm as the policy uncertainty and ex ante risk premiums decrease. We show this to have been the case for federal elections held over the past two centuries. We argue that the political uncertainty, which we measure primarily by the Economic Policy Uncertainty index, tends to be a tail risk that has previously been found to be compensated by higher premiums. We also find that the “lost CAPM” for expected equity returns reappears to fit returns amidst the post-midterm flood of public information, but not at other times in the Presidential cycle. We further show that the idiosyncratic volatility and lottery-demand puzzles disappear in post-midterm months.


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