Recent literature in both finance and political science has identified a series of
systematic patterns in the way stock market responds to significant political events.
The lack of a common theoretical core as well as the use of different empirical
specifications in two literatures which hardly cross-reference each other has led to
contradictory results. Several relevant questions arise: do stock markets really
prefer Republicans or Democrats? Is divided government somehow better or worse
for the stock market?
We develop a theoretical framework to comprehend two under-theorized
mechanisms through which political factors affect stock market performance:
redistributive and regulatory policies. Two main predictions follow from the
model: stock market performs better under Democratic Presidencies and under
Divided Government. We then test them by looking at monthly changes in US
stock market performance from the 1870s until today. We control for all relevant
variables used in both previous literatures and subject the results to robustness
checks. In addition, we complement our results with historical narratives of stock
market regulation –from public policy scholars and economic historians-, which
show the mechanisms of the theory in operation
