Keywords: Presidential puzzle, realized volatility, range based volatility
Abstract: Since the early 1980s much research, including the most recent contribution of
Santa-Clara and Valkanov (2003), has concluded that there is a stable, robust and significant
relationship between Democratic presidential administrations and robust stock returns.
Moreover, the difference in returns does not appear to be accompanied by any significant
differences in risk across the presidential cycle. These conclusions are largely based on OLS
estimates of the difference in returns across the presidential cycle. We re-examine this issue
using more efficient estimators of the presidential premium. Specifically, we exploit the
considerable and persistent heteroskedasticity in stock returns to construct more efficient
weighted least squares (WLS) and generalized autoregressive conditional heteroskedasticity
(GARCH) estimators of the difference in expected excess stock returns across the presidential
cycle. Our findings provide considerable contrast to the findings of previous research. Across
the different WLS and GARCH estimates we find that the point estimates are considerably
smaller than the OLS estimates and fluctuate considerably across different sub samples. We
show that the large difference between the WLS, GARCH and OLS estimates is driven by
differing stock market performance during very volatile market environments. During periods of
elevated market volatility, excess stock returns have been markedly higher under Democratic
than Republican administrations. Accordingly, the WLS and GARCH estimators are less
sensitive to these episodes than the OLS estimator. Ultimately, these results are consistent with
the conclusion that neither risk nor return varies significantly across the presidential cycle.
Full paper (417 KB PDF)
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Last update: January 3, 2005