Trade of goods and services and risk sharing ability in international equity markets: Are these substitutes or complements?

Abstract

This paper shows that changes in risk sharing ability in international financial markets have implications for the trade of goods and services. The ability to share risk in international financial markets is captured as time varying correlations between stock markets in the US and 11 Asian countries. We find that trade in the 11 Asia and their ability to share risk in US equity market are mostly substitutes over the full sample (1993:01 to 2014:01) and in extreme market conditions (such as a financial crisis). However, once we account for the decoupling-recoupling hypothesis during the GFC period, we only find strong evidence of complementarity between Asian trade and risk sharing in the US stock markets. We find further support for this complementary link between the real and financial markets in our analyses of when we examined the relationship between US stock market spillovers and Asian trade during the full sample, the GFC period, and under bearish market conditions. We explain our approach and results making connections with several related areas of research and evaluate the results against cases where international risk sharing is with equity markets in China and Japan.