A study of the relationship between U.S. stock market returns and the political environment

Abstract

This master’s thesis examines the relationship between the political environment and the stock market returns. The main focus is whether there are differences in the stock market returns under different political parties, if the political environment assembles a cycle in the stock market returns and if the stock market returns can be used to predict the outcomes of reelections. There have been several studies that have found possibilities of earning abnormal returns above the market portfolio, and this is in contradiction to the Efficient Market Hypothesis. As we learnt more about this topic we found that previous studies have reached different conclusions about the relationship and that the solution to this anomaly was not yet solved. This triggered us to investigate the topic further and attribute knowledge to the existing literature. This study uses the t-test and F-test to perform analyses on data from the period of 1871 to 2012. We find that the party effect was present for the excess returns, returns were higher in the latter half of presidential periods and that stock market returns can predict the outcomes of reelections. The conclusion is that there could be a political environment that affects the stock market returns.