The Effects of Trade War Risk on U.S. Financial Markets
31 Pages Posted: 18 Mar 2020
Date Written: February 21, 2020
This paper investigates the effects of trade war risk on various U.S. financial variables using a structural vector autoregression model identified by a heteroscedasticity-based approach. The empirical results indicate that increases in trade war risk cause declines in equity prices, Treasury yields and inflation expectations, a widening of BAA corporate spreads, a fall in the dollar against the yen, and rises in gold prices and stock market volatility. More importantly, we find that concerns about risks from the trade war may be overblown. Trade war risk shocks did not account for as large of a portion of the variances in the financial variables as expected over the sample period we consider, whose contribution was short-lived, quickly settling down to even smaller unconditional shares. Additional studies employing stock prices in the S&P 500 index to explore potential transmission channels show that firms with high input or output exposures to China’s market suffer significantly more from trade war risk.
Keywords: Trade war, Financial markets, Identification by heteroscedasticity, Vector autoregression
JEL Classification: C22, F10, G12
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