It is unusual for a serious academic paper to analyze events that occurred within a month of the paper’s release. But economists Justin Wolfers and Eric Zitzewitz were able to pull it off, producing a high-quality study of financial markets’ views of the 2016 election.
The chart below tells much of the story. It shows changes in the stock market and changes in the probability of Secretary Clinton winning the election (as measured by prices in prediction markets) around the hours during which the first presidential debate occurred. During the debate, both Secretary Clinton’s probability of victory increased and the stock market (specifically, S&P 500 futures) increased.
The simplest explanation of these facts seems to be the most plausible: Mr. Trump performed poorly in the debate, the probability that Secretary Clinton will be elected president increased, and market participants reacted, revealing that they believe the S&P 500 will be worth quite a bit more (12 percent is Wolfers and Zitzewitz’s headline number) under a President Clinton.
Here’s the abstract of their paper:
On September 26, 2016, Hillary Clinton was regarded by post-debate polls to have defeated Donald Trump in the first Presidential debate, and her odds of election in the Betfair prediction market increased from 63 to 69 percent. Given that most financial markets are typically quiet during that time, movements in asset prices likely reflect market participants’ collective view of the impact of the 2016 election. During the debate event window, U.S., U.K. and Asian stock markets rose, crude oil rose, the currencies of trading partners such as Mexico, South Korea, and Canada rose against the dollar, and expected future U.S. stock market volatility dropped sharply. Given the magnitude of the price movements, we estimate that market participants believe that a Trump victory would reduce the value of the S&P 500, the U.K., and Asian stock markets by 10-15%, would reduce the oil price by $4, would lead to a 25% decline in the Mexican Peso, and would significantly increase expected future stock market volatility.
Market movements over the October 7-9 weekend, during which a tape was released that prompted many Republicans to unendorse Trump, tell a largely consistent story. Clinton’s probability of election rose, stocks rose, volatility fell, and the currencies of Mexico and Canada rose against the dollar.
Here’s more detail from their paper on an additional interesting finding: “Foreign exchange markets suggest that some of this is driven by trade. The currencies of Mexico and Canada — both of which are partners in NAFTA, which Trump has threatened to end or renegotiate — rose sharply, as did those of other nations with which the U.S. has free trade agreements, including South Korea, Australia, and New Zealand. The Japanese Yen was the only major currency to decline against the dollar during the debate.”
Their paper studies the real world, which is much more complicated than a lab experiment or than the chart above might suggest. Other explanations are possible. Instead of reacting to an increase in the odds of a President Clinton, it could be that the markets were expecting something closer to a pro-wrestling match in the first debate than actually occurred, and the stock market increase was akin to it breathing a sigh of relief. Or it could be that prediction markets aren’t up to the job here, and don’t contain enough nuanced information to tell us how financial markets view the world under a President Clinton relative to a President Trump.
But the qualitative conclusion of the paper rings true to me, in no small part because of the quality and rigor of the Wolfers and Zitzewitz study: Markets believe that the value of U.S. assets would be higher under a President Clinton than a President Trump, that future stock market volatility will be lower, and are especially worried about trade.
And after all, it ain’t only markets that hold those views.
Wolfers and Zitzewitz remind that for over a century equity markets have risen when Republicans win the White House. “Our findings,” they write, “represent a break from history.”
Just one break among many in an election cycle that can’t end too soon.