Parties, Congress, and the Stock Market

Abstract

Recent literature in both finance and political science has identified a series of systematic patterns in the way stock market responds to significant political events. The lack of a common theoretical core as well as the use of different empirical specifications in two literatures which hardly cross-reference each other has led to contradictory results. Several relevant questions arise: do stock markets really prefer Republicans or Democrats? Is divided government somehow better or worse for the stock market? We develop a theoretical framework to comprehend two under-theorized mechanisms through which political factors affect stock market performance: redistributive and regulatory policies. Two main predictions follow from the model: stock market performs better under Democratic Presidencies and under Divided Government. We then test them by looking at monthly changes in US stock market performance from the 1870s until today. We control for all relevant variables used in both previous literatures and subject the results to robustness checks. In addition, we complement our results with historical narratives of stock market regulation –from public policy scholars and economic historians-, which show the mechanisms of the theory in operation.