Performance Analysis of U.S. Defense Stocks in Relation to Federal Budgets and Military Conflicts in the Post-Cold War Era
22 Pages Posted: 27 May 2017
Date Written: April 2017
Since the start of the millennium, U.S. engagements in direct and indirect military conflicts around the world have accelerated significantly, relative to the previous decade. At the same time, the nature of these conflicts shifted away from involving predominantly state forces toward the conflicts involving non-state actors, such as terrorist groups and nationalist/sectarian insurgencies. The changing nature of conflicts and the evolving strategic responses to these warrant a re-examination of the relationship between the U.S. military engagements and the defense suppliers. In this paper, we investigate the reaction of large cap U.S. defense firms’ share prices to spending announcements by the U.S. government and conflict engagements ranging from direct military interventions to indirect conflicts participation. We also explicitly consider the existence and duration of the defense spending announcement effect. Our results suggest that the relationship between defense stocks and budget announcements is long-run in nature. We suspect that this is due to the longer federal budgetary processes and information disclosures leading up to the budgetary decisions. We also find that indirect involvement in foreign conflicts has a significant positive impact on returns to defense stocks. This supports our view that involvement in a conflict will only deliver significant positive returns to defense stocks if there remains an element of market surprise regarding the future direction or escalation of the conflict. Direct involvement in conflicts, in contrast, is found to be insignificant owing to a related certainty factor. We identify a key distinction between direct and indirect involvement in conflict - the investors can incorporate their future expectations of the conflict and how it will affect a given defense stock into the current market price for the former far more accurately than the latter.
Keywords: U.S. defense stocks, conflicts, U.S. military engagements, stock prices, foreign conflicts
JEL Classification: G12, G14, G18, H56
Suggested Citation: Suggested Citation