Three dummies and the stock market

There are large literatures about the role of three dummy variables in explaining economic activity: Republican elections, oil shocks, and Romer dates, which mark monetary tightening. Many have argued that one or more of the three is not a cause of recessions. This paper parallels those literatures in examining equity returns and the three dummies. Given that equity returns vary with the business cycle, it seems likely that the dummies will predict asset returns, and they do. The losses that predictably follow the dummy events, however, do not come when the dummy events happen, but later when the business cycle peak actually occurs. Based on this, we argue that the markets, at least, are also suspicious of the evidence that the dummies signal recession.