Trade Policy Uncertainty and Stock Returns

Esposito, Federico and Bianconi, Marcelo and Sammon, Marco (2020): Trade Policy Uncertainty and Stock Returns.

Abstract

We examine how trade policy uncertainty is reflected in stock returns. Our identification strategy exploits quasi-experimental variation in exposure to trade policy uncertainty arising from Congressional votes to revoke China's preferential tariff treatment between 1990 and 2001. More exposed industries commanded a risk premium of 6% per year. The risk premium was larger in sectors less protected from globalization, and more reliant on inputs from China. More exposed industries also had a larger drop in stock prices when the uncertainty began, and more volatile returns around key policy dates. Moreover, the effects of policy uncertainty on expected cash-flows, investors' forecast errors, and import competition from China cannot explain our results.

• Item Type: MPRA Paper
• Language: English
• Keywords: Trade policy; uncertainty; risk premium; China shock
• Subjects: F - International Economics > F1 - Trade; F - International Economics > F6 - Economic Impacts of Globalization > F60 - General; G - Financial Economics > G1 - General Financial Markets > G10 - General

References

Adao, R., Arkolakis, C., Esposito, F., 2019. Spatial linkages, global shocks, and local labor markets: Theory and evidence. Tech. rep., National Bureau of Economic Research. Alessandria, G., Khan, S., Khederlarian, A., 2019. Taking stock of trade policy uncertainty: Evidence from china. Tech. rep., National Bureau of Economic Research. Alfaro, I., Bloom, N., Lin, X., 2018. The finance uncertainty multiplier. Tech. rep., National Bureau of Economic Research. Bachmann, R., Elstner, S., Sims, E. R., 2013. Uncertainty and economic activity: Evidence from business survey data. American Economic Journal: Macroeconomics 5 (2), 217--49. Baker, S. R., Bloom, N., Davis, S. J., 2016. Measuring economic policy uncertainty. The Quarterly Journal of Economics 131 (4), 1593--1636. Baker, S. R., Bloom, N., Davis, S. J., Kost, K. J., 2019. Policy news and stock market volatility. Tech. rep., National Bureau of Economic Research. Bali, T. G., Brown, S. J., Tang, Y., 2017. Is economic uncertainty priced in the cross-section of stock returns? Journal of Financial Economics 126 (3), 471--489. Banz, R. W., 1981. The relationship between return and market value of common stocks. Journal of financial economics 9 (1), 3--18. Barrero, J. M., Bloom, N., Wright, I., 2017. Short and long run uncertainty. Tech. rep., National Bureau of Economic Research. Barrot, J.-N., Loualiche, E., Sauvagnat, J., 2018. The globalization risk premium. Journal of Finance, Forthcoming. Black, F., Scholes, M., 1974. The effects of dividend yield and dividend policy on common stock prices and returns. Journal of financial economics 1 (1), 1--22. Blaum, J., Esposito, F., Heise, S., 2020. Input sourcing under risk: Evidence from u.s. firms. Working paper. Bloom, N., 2009. The impact of uncertainty shocks. econometrica 77 (3), 623--685. 30 Bloom, N., Bond, S., Van Reenen, J., 2007. Uncertainty and investment dynamics. The review of economic studies 74 (2), 391--415. Boutchkova, M., Doshi, H., Durnev, A., Molchanov, A., 2012. Precarious politics and return volatility. The Review of Financial Studies 25 (4), 1111--1154. Brandt, L., Van Biesebroeck, J., Wang, L., Zhang, Y., et al., 2012. WTO accession and performance of Chinese manufacturing firms. Centre for Economic Policy Research. Breinlich, H., 2014. Heterogeneous firm-level responses to trade liberalization: A test using stock price reactions. Journal of International Economics 93 (2), 270--285. Brogaard, J., Detzel, A., 2015. The asset-pricing implications of government economic policy uncertainty. Management Science 61 (1), 3--18. Caldara, D., Iacoviello, M., Molligo, P., Prestipino, A., Raffo, A., 2020. The economic effects of trade policy uncertainty. Journal of Monetary Economics 109, 38--59. Caliendo, L., Parro, F., 2014. Estimates of the trade and welfare effects of nafta. The Review of Economic Studies, rdu035. Campbell, J. Y., Shiller, R. J., 1988. Stock prices, earnings, and expected dividends. The Journal of Finance 43 (3), 661--676. Carr, P., Wu, L., 2008. Variance risk premiums. The Review of Financial Studies 22 (3), 1311--1341. Chen, Q., Goldstein, I., Jiang, W., 2006. Price informativeness and investment sensitivity to stock price. The Review of Financial Studies 20 (3), 619--650. Chodorow-Reich, G., Nenov, P. T., Simsek, A., 2019. Stock market wealth and the real economy: A local labor market approach. Tech. rep., National Bureau of Economic Research. Christou, C., Cunado, J., Gupta, R., Hassapis, C., 2017. Economic policy uncertainty and stock market returns in pacificrim countries: Evidence based on a bayesian panel var model. Journal of Multinational Financial Management 40, 92--102. Cochrane, J. H., 2009. Asset pricing: Revised edition. Princeton university press. Cohen, L., Frazzini, A., 2008. Economic links and predictable returns. The Journal of Finance 63 (4), 1977--2011. Crowley, M., Meng, N., Song, H., 2018. Tariff scares: Trade policy uncertainty and foreign market entry by chinese firms. Journal of International Economics 114, 96--115. Crowley, M. A., Meng, N., Song, H., 2019. Policy shocks and stock market returns: Evidence from chinese solar panels. Journal of the Japanese and International Economies 51, 148--169. Duffie, D., 2010. Dynamic asset pricing theory. Princeton University Press. Dumbaugh, K., 1998. China's most-favored-nation (mfn) status: Congressional consideration, 1989-1998. Congressional Research Service, the Library of Congress. Esposito, F., 2019. Demand risk and diversification through trade. Available at SSRN 3498593. Fama, E. F., French, K. R., 1995. Size and book-to-market factors in earnings and returns. The journal of finance 50 (1), 131--155. Fama, E. F., French, K. R., 2015. A five-factor asset pricing model. Journal of Financial Economics 116, 1--22. Feenstra, R. C., Romalis, J., Schott, P. K., 2002. US imports, exports, and tariff data, 1989-2001. NBER Working Paper 9387. Fillat, J., Garetto, S., 2015. Risk, return and multinational production. The Quarterly Journal Economics 130 (4), 2027--2073. Frazzini, A., Pedersen, L. H., 2014. Betting against beta. Journal of Financial Economics 111 (1), 1--25. Gagliardini, P., Ossola, E., Scaillet, O., 2016. Time-varying risk premium in large crosssectional equity data sets. Econometrica 84 (3), 985--1046. Graziano, A., Handley, K., Lim~ao, N., 2018. Brexit uncertainty and trade disintegration. Tech. rep., National Bureau of Economic Research. Greenland, A., Iony, M., Lopresti, J., Schott, P., 2019. Using equity market reactions to infer exposure to trade liberalization. Guiso, L., Haliassos, M., Jappelli, T., et al., 2002. Household portfolios. MIT press. Handley, K., Lim~ao, N., 2015. Trade and investment under policy uncertainty: theory and firm evidence. American Economic Journal: Economic Policy 7 (4), 189--222. Handley, K., Lim~ao, N., 2017. Policy uncertainty, trade, and welfare: Theory and evidence for china and the united states. American Economic Review 107 (9), 2731--83. Hou, K., Xue, C., Zhang, L., 2017. Replicating anomalies. Tech. rep., National Bureau of Economic Research. Huang, Y., Lin, C., Liu, S., Tang, H., 2018. Trade linkages and firm value: Evidence from the 2018 us-china'trade war'. Jord�a, � O., Schularick, M., Taylor, A. M., Ward, F., 2019. Global financial cycles and risk premiums. IMF Economic Review 67 (1), 109--150. Jurado, K., Ludvigson, S. C., Ng, S., 2015. Measuring uncertainty. American Economic Review 105 (3), 1177--1216. Kelly, B., P�astor, L., Veronesi, P., 2016. The price of political uncertainty: Theory and evidence from the option market. The Journal of Finance 71 (5), 2417--2480. Khandelwal, A. K., Schott, P. K., Wei, S.-J., 2013. Trade liberalization and embedded institutional reform: evidence from chinese exporters. American Economic Review 103 (6), 2169--95. Moser, C., Rose, A. K., 2014. Who benefits from regional trade agreements? the view from the stock market. European Economic Review 68, 31--47. Moskowitz, T. J., Vissing-J�rgensen, A., 2002. The returns to entrepreneurial investment: A private equity premium puzzle? American Economic Review 92 (4), 745--778. Nagel, S., 2013. Empirical cross-sectional asset pricing. Annu. Rev. Financ. Econ. 5 (1), 167--199. Novy, D., Taylor, A. M., 2014. Trade and uncertainty. Review of Economics and Statistics, 1--50. Pastor, L., Veronesi, P., 2012. Uncertainty about government policy and stock prices. The journal of Finance 67 (4), 1219--1264. P�astor, L., Veronesi, P., 2013. Political uncertainty and risk premia. Journal of Financial Economics 110 (3), 520--545. Petersen, M. A., 2009. Estimating standard errors in finance panel data sets: Comparing approaches. The Review of Financial Studies 22 (1), 435--480. Pierce, J. R., Schott, P. K., 2012. Concording us harmonized system codes over time. Journal of Official Statistics 28 (1), 53--68. Pierce, J. R., Schott, P. K., 2016. The surprisingly swift decline of us manufacturing employment. The American Economic Review 106 (7), 1632--1662. Pierce, J. R., Schott, P. K., 2017. Investment responses to trade liberalization: Evidence from us industries and plants. Tech. rep., National Bureau of Economic Research. Pierce, J. R., Schott, P. K., 2018. Investment responses to trade liberalization: Evidence from us industries and establishments. Journal of International Economics 115, 203--222. Shiller, R. J., 2000. Irrational exuberance princeton. Princeton University Paper. Steinberg, J. B., 2019. Brexit and the macroeconomic impact of trade policy uncertainty. Journal of International Economics 117, 175--195. Wang, Z., Wei, S.-J., Yu, X., Zhu, K., 2018. Re-examining the effects of trading with china on local labor markets: A supply chain perspective. Tech. rep., National Bureau of Economic Research.