Do WTO Rulings Really Matter? Evidence from the Rare Earth Elements Market

Abstract

Rare earth elements (REEs) have gained increasing attention recently for several key reasons: 1) they are vital to many strategic industries, 2) they are relatively scarce, 3) they frequently exhibit high price fluctuations, 4) China holds a quasi-monopoly on their mining, and 5) China’s REE policy, which was overly restrictive and led to a formal complaint from the U.S., Japan, and the EU at the World Trade Organization (WTO) in 2012. This paper investigates whether the announcement of a WTO dispute resolution case can influence governmental changes in existing policies. We find empirical support for this notion, because REE prices exhibit a structural break around the announcement of a WTO dispute, and show lower variance ratios for all tested REEs afterward. This indicates a tendency toward efficiency, although REE prices still do not follow a random walk. Similarly, we find that the stock price informativeness of companies in the REE industry increases after such an announcement, reflecting more firm-specific than marketwide information and less governmental influence. Finally, we show that the model uncertainty for option pricing models decreases, which we measure by the lower pricing differences among them.

Keywords: Market Efficiency, Rare Earth Elements, Stock Price Informativeness, Structural Break Tests, Variance Ratio Tests, World Trade Organization (WTO)

JEL Classification: C22, C58, F13, G14, G18, G28, Q02, Q38