Risk Aversion in Stocks and in Politics

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Here’s an interesting find from Justin LaHart in the Wall Street Journal, in a brief article titled “Why the Stock Market Doesn’t Like Republicans“:

The two economists created a model where people have a choice between being entrepreneurs and working for the government, and of voting for a political party that favors lower taxes or higher taxes. When risk aversion is low, more people want to be entrepreneurs and to vote for the low-tax party. When risk aversion is high, the opposite is true.

It is a highly simplified version of U.S. politics and economics. But the implications for stock prices are interesting. The low-tax party gets elected when risk aversion is low, and then if risk aversion merely returns to the mean, stocks suffer. For the high-tax party, the opposite is true.

The next question, obviously, is what causes these changes in sentiment, because the variables seem more to correlate than to cause one another.

Of course, they may have a causative relationship indirectly.  The high-tax party, for example, is likely to sense this dynamic (whether consciously recognizing it or not) and change policy in a way that makes people more risk-averse (such as regulations to make independent activity more difficulty while acclimating people to dependence on government’s socialization of risk).  Indeed, even when they promote entrepreneurialism, they strive to make it seem like something that cannot be done without the safety net of government subsidies.  (“You didn’t build that.“)

The insight has implications for advocacy, too.  Conservatives who make a theme of imminent doom under progressive rule — however accurate that theme is — may be making the public more inclined to fall for progressive promises of security.  The key, perhaps, is to make people feel secure in their families and their own ability to transcend



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