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We show that average excess returns during the last two years of the presidential cycle are significantly higher than during the first two years: 9.8 percent over the period 1948 – 2008. This pattern in returns cannot be explained by business-cycle variables capturing time-varying risk premia, differences in risk levels, or by consumer and investor sentiment. In this paper, we formally test the presidential election cycle (PEC) hypothesis as the alternative explanation found in the literature for explaining the presidential cycle anomaly. PEC states that incumbent parties and presidents have an incentive to manipulate the economy (via budget expansions and taxes) to remain in power. We formulate eight empirically testable propositions relating to the fiscal, monetary, tax, unexpected inflation and political implications of the PEC hypothesis. We do not find statistically significant evidence confirming the PEC hypothesis as a plausible explanation for the presidential cycle effect. The existence of the presidential cycle effect in U.S. financial markets thus remains a puzzle that cannot be easily explained by politicians employing their economic influence to remain in power. JEL Classification: E32; G14; P16 Keywords: Political Economy, Market Efficiency, Anomalies, Calendar Effects
Forecasting stock market volatility and the informational efficiency of the DAX-index options market
(2002)
Alternative strategies for predicting stock market volatility are examined. In out-of-sample forecasting experiments implied-volatility information, derived from contemporaneously observed option prices or history-based volatility predictors, such as GARCH models, are investigated, to determine if they are more appropriate for predicting future return volatility. Employing German DAX-index return data it is found that past returns do not contain useful information beyond the volatility expectations already reflected in option prices. This supports the efficient market hypothesis for the DAX-index options market.