Working Paper: NBER ID: w23184
Authors: Lubos Pastor; Pietro Veronesi
Abstract: We develop a model of political cycles driven by time-varying risk aversion. Agents choose to work in the public or private sector and to vote Democrat or Republican. In equilibrium, when risk aversion is high, agents elect Democrats—the party promising more redistribution. The model predicts higher average stock market returns under Democratic presidencies, explaining the well-known “presidential puzzle.” The model can also explain why economic growth has been faster under Democratic presidencies. In the data, Democratic voters are more risk- averse and risk aversion declines during Democratic presidencies. Public workers vote Democrat while entrepreneurs vote Republican, as the model predicts.
Keywords: Political cycles; Stock returns; Risk aversion; Economic growth
JEL Codes: D72; G12; G18; P16
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Democratic presidencies (D72) | Higher average stock market returns (G17) |
| Higher risk aversion (D81) | Likelihood of electing a Democratic president (D79) |
| Likelihood of electing a Democratic president (D79) | Higher average stock market returns (G17) |
| Higher average stock market returns (G17) | Faster economic growth (O49) |
| Risk aversion (D81) | Average stock market return (G17) |