The Price of Political Uncertainty: Evidence from the 2016 U.S. Presidential Election and the U.S. Stock Markets

TL;DR

This study investigates how the 2016 U.S. presidential election influenced stock market reactions across sectors, revealing sector-specific responses and challenging the uncertain information hypothesis.

Contribution

It provides sector-level analysis of market reactions to election uncertainty, using event-study methodology to test the uncertain information hypothesis in the context of the 2016 election.

Findings

Positive abnormal returns on election day, except in some cases.

Sector-specific winners and losers post-election.

Results do not support the uncertain information hypothesis.

Abstract

There is bountiful evidence that political uncertainty stemming from presidential elections or doubt about the direction of future policy make financial markets significantly volatile, especially in proximity to close elections or elections that may prompt radical policy changes. Although several studies have examined the association between presidential elections and stock returns, very little attention has been given to the impacts of elections and election induced uncertainty on stock markets. This paper explores, at sectoral level, the uncertain information hypothesis (UIH) as a means of explaining the reaction of markets to the arrival of unanticipated information. This hypothesis postulates that political uncertainty is greater prior to the elections (relative to pre-election period) but is resolved once the outcome of the elections is determined (relative to post-election period). To this end, we adopt an event-study methodology that examines abnormal return behavior around the election date. We show that collapsing stock returns around the election result is reversed by positive abnormal return on the next day, except some cases where we note negative responses following the vote count. Although Trump's win plunges US into uncertain future, positive reactions of abnormal return are found. Therefore, our results do not support the UIH hypothesis. Besides, the effect of political uncertainty is sector-specific. While some sectors emerged winners (healthcare, oil and gas, real estate, defense, financials and consumer goods and services), others took the opposite route (technology and utilities). The winning industries are generally those that will benefit from the new administration's focus on rebuilding infrastructure, renegotiating trade agreements, reforming tax policy and labour laws, increasing defense funding, easing restrictions on energy production, and rolling back Obamacare.