The Monkey Cage

This paper shows that people’s optimism towards financial markets and the overall economy is dynamically influenced by their political affiliation and the existing political climate. Republicans (Democrats) are more optimistic and they perceive the markets to be less risky and more undervalued when the Republican (Democratic) party is in power. These optimism shifts are more pronounced among individuals with lower financial sophistication. Further, when the opposite party is in power, investors lower their forecasts of market returns, keep own portfolio return forecasts unchanged and, therefore, appear more overconfident. These shifts in optimism, overconfidence, and perceptions of risk and reward influence people’s investment decisions. Specifically, investors with a pessimistic view of the domestic economy exhibit strong propensity to invest in foreign stocks and in the domestic setting, they gravitate toward less risky, familiar local stocks and trade more actively. Investors improve their raw portfolio performance when their own party is in power, but the improvement in risk-adjusted performance is economically small.

The paper is by Yosef Bonaparte, Alok Kumar, and Jeremy K. Page (here). Hat tip to this NY Times article. Some of these findings depend on categorizing investors based as Republican or Democrat based on the political leaning of the counties in which they lived. That is obviously imprecise, although not necessarily fatal. The results struck me as substantively small in magnitude — e.g., when the Democrats controlled the White House, Republic portfolios had a 9% greater foreign stake compared to Democratic portfolios. Similarly, in-party portfolios manifested 1.3% higher levels of risk and — based in part on higher trading in out-party portfolios — 2.7% better performance. But substantive significance is sometimes specific to the topic, and I profess no knowledge of this one.