What Did the Stock and Option Markets Think of the Trump Tax Cut of 2017?

How do we know what the market actually thought of the Trump tax cuts of 2017? I describe a method for estimating the stock market impact of aggregate events. Based on using data on both stock and options prices, this technique accounts for two important sources of bias present in traditional methods. First, the method takes into account market anticipation, without the need for information on specific firm characteristics. Many event studies only measure a fraction of an event's full value effect, so the measured market reaction at event resolution can be misleading, particularly in the case of a very high degree of market anticipation. Second, the method is robust to the possibility of the event being good news for some firms and bad for others, without prior specification of this heterogeneity.

The Tax Cuts and Jobs Act (TCJA, aka the Trump tax cut) exhibits both anticipation and heterogeneity. My coauthors and I estimate the market anticipated the probability of passage to be as high as 95% 30 days before the event. The full value impact of the TCJA is found to be 12.36%, compared to 0.68% when market anticipation is ignored. The firm-level impact of the TCJA is considerably heterogeneous, with large and innovative firms with high growth prospects being the largest winners.

This presentation, made at the Financial Management Association 2021 Annual Meeting, draws on my own research available at https://papers.ssrn.com/sol3/cf_dev/A....