Politics and Investment Bias

One thing that looks anecdotally true is that perceptions of the economy depend in part on the conceiver’s politics. One salient recent example is that even though the dollar reached the low point of its value in spring 2008, relatively few rightwingers were upset at the time. Then the financial crisis caused the dollar to skyrocket relative to the euro, but since the end of mass panic there’s been an Obama-era slide back in the direction of the Bush-era low, and this has many conservatives freaked out.

Larry Bartels has demonstrated (PDF) fairly systematic biases of this sort, where perceptions of the size of the budget deficit and the unemployment rate are driven in part by partisanship.

Freedom/slavery loving tea partier (my photo, available under cc license)

Freedom/slavery loving tea partier (my photo, available under cc license)

Talk, however, is cheap. What about real behavior. Well here come Yosef Bonaparte, Alok Kumar, and Jeremy K. Page with “Political Climate, Optimism, and Investment Decisions”:

This paper shows that people’s optimism towards financial markets and the overall economy is dynamically influenced by their political affiliation and the existing political climate. Republicans (Democrats) are more optimistic and they perceive the markets to be less risky and more undervalued when the Republican (Democratic) party is in power. These optimism shifts are more pronounced among individuals with lower financial sophistication. Further, when the opposite party is in power, investors lower their forecasts of market returns, keep own portfolio return forecasts unchanged and, therefore, appear more overconfident. These shifts in optimism, overconfidence, and perceptions of risk and reward influence people’s investment decisions. Specifically, investors with a pessimistic view of the domestic economy exhibit strong propensity to invest in foreign stocks and in the domestic setting, they gravitate toward less risky, familiar local stocks and trade more actively. Investors improve their raw portfolio performance when their own party is in power, but the improvement in risk-adjusted performance is economically small.

This comes via John Sides who notes that the magnitude of the effect seems pretty small.