Political and the Dow Jones Industrial average indices fell

Political events have a big
influence on the financial market. Because of political decision making new
information becomes available. The financial markets try to incorporate this
information in the stock prices. The presidential election is a unique event,
since after the election the voters have no more influence on the decision
making in politics. Therefore it is interesting for investors to keep an eye on
these political events and the results.The 58th
quadrennial American presidential election, which was held on November 8 2016,
was won by the republican candidate Donald John Trump. By beating the
democratic presidential candidate Hilary Clinton, Donald Trump became the 45th
president of the United States of America. The outcome of the 2016 election is
viewed as one of the most shocking outcomes in modern political history. Since
Donald Trump, a business man and a reality television star who has no
government experience, defeated the former secretary of state. Trump ran a
controversial campaign that focused on immigration control and included among others
building a wall along the United States border with Mexico and a proposal to
ban Muslims from entering the United States. He also made comments about
withdrawing from several trade and international agreements like the Trans
Pacific Partnership(TPP), NAFTA, the Paris Climate Accord, The U.S.-Cuba deal
and NATO. Since being elected Donald Trump has made progress or successfully
fulfilled withdrawment or adjustment of most of these agreements and comments. On the night of the election,
as the results came in, the markets went wild. Futures for the benchmark
S&P 500 and the Dow Jones Industrial average indices fell more than four
per cent(Kiersz, 2016). The stock markets recovered quickly and since the
election of Donald J. Trump the S&P 500 has performed exceptionally well.
Between the election of Donald J. Trump on November 8th 2016 and
September 2017 the S&P 500 has added 2.04 trillion dollars in market value (Imbert,
2017). The presidential election of
the United States is a large world event. The election outcome could change
trading regimes, since the president can alter import tariffs as well as cancel
trade agreements without much intervention from the US Congress. Also the
United States of America is one of the biggest countries in the world
concerning import and export. Since the current literature about the effect of
elections on market indexes their return and volatility focuses mainly on the
domestic market this thesis will be focused on the effect of the U.S. election
outcome on the economy of the countries with a strong trade-relationship with
the United States.For investors it is important to know how the markets respond to certain
events, so they can alter their trading strategy. This thesis will try and answer the following
question:Do the political elections in the
United States of America have an abnormal effect on the market index return of
the current top trade partners of the U.S.A.?In this study the daily stock returns of the thirty current top trade
partners of the United States will be used. The top trade partners are selected
by their total amount of export to the United States. Following MacKinlay(1997)
an event study will be used to investigate if cumulative abnormal returns of
market indexes of the top trade partners are significantly different from zero
at election day. After the event study a cross-section analysis will be
conducted to research which factors influence the cumulative abnormal returns. This thesis is organized as following. Section 2 will discuss relevant
literature. Section 3 will explain data used for this study. Section 4 covers
the methodology. In section 5 the results will be stated and discussed. And
finally section 6 will cover the conclusion and additionally the limitations of
this research and suggestions for further research.   

 Literature reviewThis section will cover
existing literature about the relationship between political events and market
indexes. Following this literature several hypothesis will be formed.             Huang(1985) researched the pattern of
common stock returns over the four year election cycle as well as over
different administrations. Their research shows a strong pattern in the four
years of the election cycle. The existence of an election cycle is much more
apparent when combined returns are shown between the first and second year and
the third and fourth year. The combined return is notably higher in the third
and fourth year compared to the combined first two years of the election cycle.
The pattern is especially large in the most recent 20-year period of their
research, were the annual difference is exceeding 24 per cent(Huang, 1985).            F. Siokis and P. Kapopoulos(2007)
examined if the movements of stock prices in a small open economy could be
partly explained by the dynamics of the political environment. They researched
the stock market of Greece by using the ASE index. In their paper they
confirmed previous findings of the importance of political events in explaining
the behavior of the stock exchange. They found evidence of both partisan and
electoral effects on the prices of stocks, especially in the in period from
1988 till 2004(F. Siokis and P. Kapopoulos, 2007).            A.F. Herbst and C.W. Slinkman(1984)
found strong support for a four year political-economic cycle. Their results
also showed the existence of a two year cycle, although it did not peak during
the election date and therefore is not labeled as a political cycle.Based on multiple studies where political cycles are
found the following hypothesis is formed: The
cumulative average abnormal returns in the period surrounding the election will
be non-zero for the thirty top trading partners. This can be expressed as
following:H0: CAAR = 0H1: CAAR ? 0            Niederhoffer
et al. (1970) found evidence for the traditional Wall Street view that the
market prefers republicans. Their results showed significant rise in the Dow
Jones Index the day following a republican victory. After a republican victory
the Dow Jones Index on average rose by 1,12 per cent, while the Dow Jones Index
on average fell by 0,81 per cent following a democratic victory. This is also
the case for the first month following the election(Niederhoffer, et al.,
1970). A more recent research of Huang(1985) contradict the
finding of Niederhoffer et al.(1970). They found evidence against the myth that
markets prefer a republican administration over a democratic administrations.
The results obtained in the research didn’t show any significant difference
between the two administrations in four out of the six cases. Although for the
two periods with a significant difference both showed higher returns for a
democratic administration.  Also research
of for example Allvine and O’Neill(1980) and from Santa-Clara and Valkanov(2003)
have found that the election of a democratic administrations predicts positive
stock market returns. Based on these finding the following hypothesis is
formed:The
cumulative abnormal return in the election period will be higher when a
democratic administrations is elected. Which can be expressed as following:H0: ?2 = 0H1: ?2 > 0            In
the research of Bialkowski, et al.(2006) is found that one of the factors that
effects the stock market volatility is a change in political regime. According
to their findings the volatility of stock prices rises when the political
orientation of the elected administration changes. The model made by Pastor and
Veronesi(2012) confirms the results found by Bialkowski, et al.(2006) that
stock prices should fall when there is a change in government policy, which can
be assumed when there is a change in political administrations. Following this
knowledge the following hypotheses is formed:A change in the political orientation because of the election will
result in lower cumulative abnormal returns. H0: ?3= 0H1: ?3 < 0            According to the research of Herbst and Slinkman(1984) the stock markets tend to rise more pre-election than post-election and therefore stock market are more favorable towards expectations than realization. Niederhoffer, et al.(1970) also found that stock prices tend to rise before an election, but only when a big victory is expected. Therefore they assume that there is a relation between the change in the market index and the margin of victory. Bialkowski, et al.(2006) also found that one of the factors that increases volatility of the stock market is the margin of victory. And therefore confirms that market indexes tend to fall when there is uncertainty about who will win the election. Following this findings the hypothesis is formed:A large margin of victory will have a negative effect on the cumulative abnormal returns. Which can be expressed as following:H0: ?5 = 0H1: ?5 < 0            Di Giovanni and Levchenko(2009) discuss the relationship between openness to trade and the volatility of the domestic stock market in their paper. Although they couldn't conclude that a higher trade openness makes countries more exposable to external shocks, because of the high difference between countries, they could conclude the following. First, the higher the trade in a certain sector, the higher the volatility in that sector(di Giovanni and Levchenko, 2009). Secondly, an economy with more trade has a higher specialization. Their results show that a change in trade openness is accompanied by an estimated rise in aggregate volatility. This volatility is about five times higher for developing countries than for developed countries.             Milner and Rosendorff(1997) have examined the impact of elections on international cooperation. They found that elections make the endorsements of international agreements problematic, because of the uncertainty surrounding elections. Because elections can usually not be completely predicted, the negotiators have to guess what kind of agreement will be acceptable for the future legislator(Milner and Rosendorff, 1997).             From the studies from di Giovanni and Levchenko(2009) and from Milner and Rosendorff(1997) it can be assumed that elections have a bigger impact on economies with international agreements and more trade with the country where the election takes place. Since the election brings more uncertainty for these countries concerning their export and economy the following hypothesis is formed:A larger amount of export from a country will have a non-zero effect on the cumulative abnormal returns during the election period. This can be expressed as following:H0: ?1 = 0H1: ?1 ? 0   Data and MethodologyDataTo perform an event study on the effect of the presidential elections in the United States on their trade partners, the current largest exporters to the U.S. have to be selected together with their matching market indices. Market indices are used because of their intent to represent entire stock markets (https://www.investopedia.com/). The U.S. department of Commerce is used as a source for the most current data of total export by countries to the United States. The database of the U.S. department of commerce has historical data available till 1985. Therefore the exports of 1985 as an estimate of the export of 1984. The elections from before 1984 are not included in this study, because of the lack of data from market indices in that time period. Also the top of exporters to the United States changes over the years, which makes the period of 1984 till 2016 more representative. The data about the elections results is retrieved from the electoral college website(Historical election results, 2016).Datastream database. Not all elections are included for the analysis in all thirty countries, because of the availability from the market indices that does not go back till 1984 in all cases. The historical Gross Domestic Products(GDP) of the countries in the study is retrieved from the World Bank. There is no data of the GDP of Taiwan, and therefore Taiwan will not be included in the cross section analysis. Both the daily prices of the indices and the GDPs are converted to US$ with the use of historical exchange rates.To be able to calculate the expected return without the event the MSCI indices are used. The MSCI indices includes the most representable stocks from several countries in the particular market. Which MSCI index is used depends on the country and its region and can be seen in table 4 in the appendix. MethodologyThis study will use an empirical event study to test if the U.S. presidential elections have an effect on the U.S. their largest trade partners. The event study pioneered by Fama, Fisher, Jensen and Roll(1969) will be used for event study. First the period of the research will be discussed, followed by the methodology for abnormal returns. According to MacKinlay(1997) both an estimation period and an event period have to be specified for the event study. The estimation period(T0,T1) will be one year before the event period and therefore consist of 261 trading days. The estimation window will be slightly smaller for the event of 1984 because of the start of many indices on January 1984. The event itself is election day, the event window(T1,T2) will be four days, one day before and two days after the event. This event window is chosen because of the different time zones in the studied countries and because of the weekend before the election day.  The daily return of the market indices in the chosen period will be calculated using the following formula. In this formula  represents the daily return of the market index on day t.  is the price index on day t and  is the prices index on the day before .The following formula is used to calculate the daily abnormal returns of market index i at day t. Where  represents the observed daily return on the market index and  represents the daily expected return of the index without the event.When the market model is used to calculate the expected return the residuals can be seen as estimates of the abnormal return(Fama, et al., 1969). Rewriting the above formula gives the following:The OLS-estimators are estimated by the following OLS-regression:The cumulative abnormal return is given by: The test is about more than one country and therefore we use an average of the cumulative abnormal returns. By testing this average we can tell if there is a significant effect on all of the trade partners instead of one of the trade partners.             The cumulative average abnormal returns(CAAR) will be tested for their significance from zero. A significant CAAR implies that the presidential election in the United States have an impact on the countries that have the largest export to the United States. The results will be tested for significance using their t-values. Since the actual standard deviation is unknow the following formula will be used to as an estimator of the standard deviation:The t-statistic would then be calculated with the formula:The study will also contain a cross-section analysis. This analysis will research which variables of the election have a significant influence on the CARs. The control variables are based on existing literature. The regression model used, is as followed:Where Export is the natural logarithm of the export as a percentage point of the Gross Domestic Product. Demo is a dummy variable which is 1 if the elected president is a democrat and 0 if the elected president is a republican. ChangeRegime is also a dummy variable which is 1 if there is a change in political administration because of the election and 0 if the administration stays the same. Demo*ChangeRegime is an interaction variable. And Margin is the percentage points above 50 per cent of the electoral votes of the elected president. All of the regression in the study will be conducted with robust standard errors to avoid heteroscedasticity.   ResultsIn this chapter the results of the event study and the cross section analysis are presented and analyzed. The study is conducted as is described in the methodology section. The cumulative abnormal returns are an indicator for the abnormal returns per event. In addition the cumulative average abnormal returns show the aggregate effect of the presidential election on a country level. Both variables are presented in the appendix with the corresponding t-statistic. In this section significant results of the cross section analysis will be marked with asterisks. One asterisks is shown for a significance at a ten per cent level, two asterisks for significance at the five per cent level and one asterisks for significance at the one per cent level. Results will be discussed on both individual country level as well as all the countries, trade partners, combined. Table 4 in the appendix shows the cumulative abnormal returns per country and per event. The cumulative abnormal returns are tested for their significance. Table 2 summarizes the cumulative average abnormal returns per country and their corresponding t-statistic. The results of the analyses show very different results in significance both per event and per country.             The cumulative abnormal returns per event and country are not significant in almost all the cases. Therefore there is no evidence of the individual effect of the event. Although when the cumulative average abnormal returns of the countries are tested for significance the results are different. The cumulative average abnormal returns show significance in thirteen out of the thirty countries. This suggest that the presidential election of the United States has an effect on some of the countries, although not all the trade partners. This suggestion is confirmed by a regression on all the cumulative average abnormal returns. This regression showed that there is a 18,8 per cent change that the found cumulative average abnormal returns are actually zero. There is not enough evidence to suggest that the presidential election in the United States has a significant effect on all the top trading partners of the U.S. Therefore hypothesis 1 can be rejected. When the above model is regressed on all of the cumulative abnormal returns none of the variables are found to be significant. These results are to be expected since most of the observed cumulative abnormal returns were not significant. The output of the regression on only the countries with a significant cumulative average abnormal return is therefore more representable result and will be further discussed from here on.            Each of the independent variables, except for the export, have been suggested to be an explanatory variable by academic literature for the cumulative abnormal returns created by the presidential election in the United States. The export as a percentage of the GDP has a significant positive effect on the cumulative abnormal returns at the 5% level. This result suggests that both the gross domestic product and the export to the United States of a country have an impact on the returns around an election. The beta of 0.722 suggest that a change of one percent in the export as a percentage of the GDP results, on average, in an 0.00722 percentage points increase in the returns of the index. This findings are in line with the suggestion made based on the literature of di Giovanni and Levchenko(2009) and Milner and Rosendorff(1997). Therefore the following hypothesis will not be rejected: A larger amount of export from a country, as a percentage of their GDP,  will have a negative effect on the cumulative abnormal returns during the election period.              A democratic administration has a positive effect on the cumulative abnormal returns, which is in line with the research from, among others, Allvine and O'Neill(1980), Santa-Clara and Valkanov(2003) and Niederhoffer et al. (1970). Although in this study there is no significant evidence that it matters which administration wins for the top-trade partners. Therefore the following hypothesis can be rejected:        The cumulative abnormal return in the election period will be higher when a democratic administrations is elected.            A change in administration, republic of democratic, has a large positive effect on the cumulative abnormal returns of the countries. This finding contradicts the expectation formed by the research of Pastor and Veronesi(2012) that stock prices should fall when there is a change in the political orientation. Although the coefficient in this study is relatively large, it is not significant and therefore there is no evidence that a change in political orientation affects the stock market of the top trade partners. This result causes a rejection of the following hypothesis: A change in the political administration because of the election will result in lower cumulative abnormal returns.             The margin of victory in the election has no significant effect on the cumulative abnormal returns of the trade partners. This is in contradiction with the findings of Bialkowski, et al.(2006) and Niederhoffer, et al.(1970) that a big victory, and therefore assumed an expected victory, has a positive effect on the market indices. This finding causes a rejection of the following hypothesis: A large margin of victory will have a positive effect on the cumulative abnormal returns.            The overall results show that all but one of the hypothesis of this study can be rejected. The presidential election is not found to be of significance on all of the trade partners. Although when the election is found to be significant the amount of export as a percentage of the GDP partly explains the abnormal returns. The rest of the variables have no significant effect. The reason that many of the studied countries show no significance could be that most of the studied countries are not fully depended on trade with the United States. Because of the low dependence the volatility can be expected to be lower and therefore the abnormal returns as well.   ConclusionThe main focus of this study was to investigate if the presidential election of the United States has an effect on the top trading partners of the U.S.. This is investigated by conducting an event study. The expected returns of the indices per country where estimated by an OLS regression on the corresponding MSCI-index. The difference between the realized and the expected return in the four day window surrounding the events is aggregated and tested for significance. In this research thirty countries and data dating back to 1984 is used to estimate the relation between the presidential election and the U.S. their current top trading partners.            The overall effect of the presidential election in the United States on their top trading partners is found to be insignificant. When limiting the analysis of explanatory variables to just the significant countries only the effect of export as a percentage of the GDP was found to be significant. Although the impact on the returns is low and only significant at a 5% level. The results suggest the presidential election in the U.S. could have a significant effect on a country, although the total amount of export to the U.S. is not the main explanatory variable. One of the limitations in this research is the prediction of the abnormal returns by using the MSCI-index. This index contains the most important stocks from several countries in the market, but therefore it is also more sensitive to other events in the area. This could cause disruption in the predicted returns without the election event. Also since there is a proven effect of the election in the domestic market this is already incorporated in the MSCI-world index which contains 54% of U.S. stocks. In future studies the research could be conducted on countries were the export to the United States is measured as a total of the export of the country. It could also be studied further if the effect of the event can be explained by the type of specialization from the countries and therefore what kind of trade takes place, instead of total trade of goods and services.    

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