WHEN ELECTIONS FAIL TO RESOLVE UNCERTAINTY: THE CASE OF THE 2016 U.S. PRESIDENTIAL ELECTION

• Author: Todd G. Griffith,Justin S. Cox
• DOI: http://doi.org/10.1111/jfir.12194
• Published date: 01 December 2019
• Date: 01 December 2019

The Journal of Financial Research Vol. XLII, No. 4 Pages 735–756 Winter 2019

DOI: 10.1111/jfir.12194

WHEN ELECTIONS FAIL TO RESOLVE UNCERTAINTY: THE CASE OF

THE 2016 U.S. PRESIDENTIAL ELECTION

Justin S. Cox

Appalachian State University

Todd G. Griffith

Utah State University

Abstract

In this article, we examine whether certain political election outcomes create, rather than

resolve, uncertainty in financial markets. We posit that the market uncertainty associated

with unanticipated election outcomes is not resolved before or on the election dates. To

test this claim, we use the surprise outcome of the 2016 U.S. presidential election and two

previous U.S. presidential elections as benchmarks. In contrast to prior elections, we find

that the 2016 U.S. presidential election outcome did not resolve market uncertainty.

Specifically, we show significant increases in transactions costs, adverse selection costs,

and volatility in the days following the election date. We contribute to the literature by

suggesting that unexpected elections can engender, rather than resolve, market uncertainty.

JEL Classification: D80, G00, G12, G14

I. Introduction

Do political elections resolve financial market uncertainty? This study examines

precise measures of stock liquidity surrounding the 2016 U.S. presidential election.

First, we investigate whether market liquidity changes in anticipation of the election

outcome. Second, we analyze whether the election outcome resolved uncertainty,

resulting in better market liquidity and less adverse selection risk. Third, we examine

the effect of election uncertainty on systematic and idiosyncratic volatility. Fourth, we

examine whether election uncertainty induced greater informational asymmetries

across various stock characteristics and for stocks in politically sensitive industries.

We contend that not all election outcomes are created equal and that the 2016

U.S. presidential election engendered, rather than resolved, financial market

uncertainty. This became apparent as media outlets reported Donald Trump’s victory

late Tuesday night, November 8, 2016, and Dow futures dropped almost 900 points and

the S&P 500 lost nearly 5% that same evening.

1,2

We use the 2012 U.S. presidential

1

See Matt Egan, “Wall Street Welcomes Trump with a Bang”CNN Money (November 9, 2016), http://

money.cnn.com/2016/11/09/investing/dow‐jones‐trump‐wins‐election/index.html.

2

Overseas markets also experienced dramatic swings following initial selloffs around the Trump election

(see Jethro Mullen and Matt Egan, “Global Markets Drop as U.S. Election Results Shock Investors”CNN

Money (November 9, 2016), http://money.cnn.com/2016/11/08/investing/global‐markets‐stocks‐trump‐clinton‐

us‐presidential‐election/index.html).

735

© 2019 The Southern Finance Association and the Southwestern Finance Association

election as a benchmark, as the outcome of that election appears to have been known in

the weeks leading up to the election date, which is clearly not the case for the 2016

election.

3

Figure I provides a time‐series depiction of the daily Iowa Election Markets

(IEM) winner‐takes‐all probabilities for both the Democratic and Republican

candidates during the 2012 and 2016 election campaigns.

4

Panel A shows that the

Democratic candidate led the Republican candidate throughout the 2016 election cycle,

with the gap widening in the final three months before the election date, but failed to

win the election. Panel B shows that the Democratic candidate led the Republican

candidate for the entire final year of the 2012 election cycle and eventually was voted

into the presidential office. Thus, voter expectations during the 2012 election campaign

were more consistent with the eventual result relative to the 2016 election.

Figure I. Iowa Election Markets Winner Takes All. The figure displays the daily results of the Iowa Election

Markets winner takes all (WTA) for both the 2012 and 2016 U.S. presidential elections (available at

https://iemweb.biz.uiowa.edu/closed/). [Color figure can be viewed at wileyonlinelibrary.com]

3

As an alternative benchmark, we use the 2004 U.S. presidential election.

4

Full results are available at https://iemweb.biz.uiowa.edu/closed/.

736 The Journal of Financial Research