Abstract
I explore empirically the interactions between international trade and stock markets. A simple Lucas-tree two-country, two-good, free-trade model with complete asset markets predicts that stock markets forecast trade flows and that stock markets react immediately and fully to news about trading partners. I test the predictions of the model and find that stock market returns of trading partners do forecast trade flows. The stock market return of a country's major trading partner predicts future exports to that partner as well as future imports from that partner. Stock markets, however, do not react immediately and fully to news about trading partners. Stock market returns of a country's major partners forecast the subsequent stock market return of that country. Strategies based on trade momentum yield monthly alphas of over 120 basis points. Trade momentum appears consistent with gradual information diffusion.
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