Government Partisanship, Elections, and the Stock Market: Examining American and British Stock Returns, 1930–2000

Abstract

We construct a model of speculative trading to examine how the mean and volatility of stock prices is affected both by government partisanship and by traders' expectations of electoral victory by the right‐wing or left‐wing party. Our model predicts that rational expectations of higher inflation under left‐wing administrations lowers the volume of stocks traded in the stock market. The decline in trading volume leads to a decrease in the mean and volatility of stock prices not only during the incumbency of left‐wing governments, but also when traders expect the left‐wing party to win elections. Conversely, expectation of lower inflation under right‐wing administrations leads to higher trading volume. This leads to an increase in the mean and volatility of stock prices during the tenure of right‐wing governments and when traders anticipate the right‐wing party to win elections. Daily and monthly data from U.S. and British equity markets between 1930 and 2000 statistically corroborate the predictions from our formal model.