Stock market and election

gaj · Post by **gaj** » Fri Aug 28, 2020 9:58 am

Is there any derivative market that relates the stock market with the election? I'm curious to find the market implied correlation between the stock market and the chance of Trump's reelection. The consensus seems to be that Trump is good for the stock market, but how big is the gap?

Dizzy · Post by **Dizzy** » Fri Aug 28, 2020 10:10 am

Well this is related to the election, but maybe not so informative if you're interested in the outcome. Smiley

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gaj · Post by **gaj** » Fri Aug 28, 2020 10:25 am

Ah yes, implied volatility on the election date is part of it.

I'm looking for something more specific though: how much will the stock market go up if Trump wins, and how much will it go down if he loses?

nikol · Post by **nikol** » Fri Aug 28, 2020 10:53 am

It depends on FED willingness to inject money, which can be processed by the financial markets.

Today I saw in my news tape too much of "market is on top, soon to crash", which make me wondering of what FED is planning.

doomanx · Post by **doomanx** » Fri Aug 28, 2020 1:37 pm

@gaj I'm not convinced this is a problem fit for statistical analysis. You could try some simple historical model say, how much did the market move for a republican vs democrat president or something like that, but you have extremely small sample size and a lot of noise, as each president was elected under different economic/geopolitical situations with different policy mandates that people are likely to take a different view on each time.

gaj · Post by **gaj** » Fri Aug 28, 2020 2:14 pm

I wasn't asking for historical statistics. I was asking if there is any betting market or a financial derivative that relates the stock market with the election. For example an SPX option that only pays off if Trump wins: max(SPX - K, 0) * 1_(Trump wins)

From the market price of a derivative like this, I'm interested to see the implied move if Trump wins or loses.

Its Grisha · Post by **Its Grisha** » Fri Aug 28, 2020 2:47 pm

I would try to model SPX against a probability time series of Trump win to get some discounted future impact. Would need to include some other risk factors to get the noise out.

By probability time series I mean market pricing on the election, attainable via betting odds on different sites. I've been looking at the TRUMP futures contract on an offshore crypto exchange a bit, not the most liquid product though.

EspressoLover · Post by **EspressoLover** » Fri Aug 28, 2020 3:19 pm

In 2016 there was a strong correlation between the Mexican Peso and Trump's odds in the betting markets. Doubt if it still holds to the same degree this election cycle. Trump seems to get along okay-ish with AMLO. But you could start with historical Betfair data, then try to find the best proxy in the liquid financial markets. (I bet post-IPO Palantir will work.)

The challenge with this election is the big source of instrumental variable bias in the form of Covid. It makes it hard to disentangle the direction of causation. If Covid gets worse (better), that's bad (good) both for the market and Trump's prospects. If you don't take that into account, you'd over-attribute the elections impact on the market. This is always kind of a baseline issue in any re-election. The economy affects both the incumbents chances and the market. But there's never been this huge amount of economic uncertainty on a two-month horizon. Modeling 2020 poses a particularly nasty three-body problem.

From what I've been reading, the election the market's watching isn't the White House but the Senate. As long as Congress is gridlocked, there probably won't be much difference between a Trump and Biden admin. Unlike Bernie or Warren, Biden's unlikely to aggressivley use executive power to push economic policy.

If Democrats control both chambers and the White House, then it's almost certain that capital gains and corporate taxes will see significant hikes. Depending how big the blue wave is, maybe even tech antitrust, FTTs, and some sort of watered-down M4A or GND. A lot of analysts seem to be saying that the best case is Biden with a Republican Senate, because you avoid both progressive legislation and Trump's twitter trade tantrums. Since that's the most likely outcome, in some sense the market may be short "election gamma". A big disruption in either side's favor could impair returns.

All this being said, in 2016 the pre-election behavior of the market totally contradicted post-election realization. The S&P 500 was pretty strongly negatively correlated with Trump's odds. For example you see a big dip the week before the election when Comey announces the re-opening of the email probe. And even the night of the election, as Trump's odds kept rising the index futures started crashing, until suddenly they reversed, rallied hard and basically kept going up and up for the next two years.

I just don't know how efficient markets are for these type of one-off events. Elections don't happen frequently enough to enforce discipline. A lot of it is just traders projecting their pre-existing biases. And they rarely pay a big enough penalty when they get it wrong.

nikol · Post by **nikol** » Fri Aug 28, 2020 4:48 pm

Implied probability of betting odds on election.

https://www.actionnetwork.com/politics/2020-election-odds-presidential-race-donald-trump-joe-biden

Validate calculations though. There are a number of betting companies.

In discussion:

You have IVOL(SnP) and ImpProb(Bets). May be try checking their historic correlation? Do not forget to check ImpProb(Bets) vs actual election results.

PS. From SnP options prices (from IVOL too) you can get p.d.f. /c.d.f. and elaborate further.

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