Financial Market Responses Research Articles

Heterogeneous firm-level responses to the US 2018 tariff announcement

PurposeThis study examines the impact of the $60 billion tariff announcement of the US government on the Chinese exporting firms. In particular, it focuses on the firms whose revenues are highly dependent on the US economy.Design/methodology/approachThis study uses an experimental analysis and the event study methodology. The sample includes firms listed in mainland China and Hong Kong Stock Exchanges that have the highest revenues from exporting to the USA. The data are obtained from China Stock Market and Accounting Research (CSMAR) and DataStream.FindingsThe authors find that the tariff announcement has significantly negative impacts on stock performance both before and after the announcement, and the impacts are heterogeneous across all sample firms. For A shares listed in Mainland China, firms with more revenues from the US experience greater price drops on the announcement day, regardless of being in the targeted industry or not. But such finding is absent from H shares listed in Hong Kong. The authors also find that for all the firms, greater pricing power can alleviate the impacts of the tariff announcement.Research limitations/implicationsThe results provide implications to investors, policymakers and regulators on the further US-China cooperation in the future.Originality/valueThis is the first study documenting the heterogeneity of the impact of the tariff announcement and thus contributes to the prosperous studies on the varied firm-level responses in the Chinese stock market, and to the burgeoning literature by filling the gap of the financial market responses to the protectionist policy announcement.

Investor attention and global market returns during the COVID-19 crisis

The financial market response to the COVID-19 pandemic provides the first example of a market crash instigated by a health crisis. As such, the crisis provides a unique setting in which to examine the market response to changes in investor attention. We utilise Google search volume (GSV) as a proxy for investor attention. GSV for the “coronavirus” keyword increases markedly from late-February and peaks in mid-March before declining substantially. Our results are broadly consistent with Da, Engelberg, and Gao (2015), indicating that GSV is primarily a proxy for the attention of retail investors and confirming that investor attention negatively influences global stock returns during this crisis period. A rise in the number of internet searches during the COVID-19 crisis induces a faster rate of information flow into financial markets and so is also associated with higher volatility. The identified relationships are economically and statistically significant even after controlling for the number of COVID-19 cases and macroeconomic effects. Increases in GSV have less impact on government bond yields where the limited role of GSV is likely due to lower participation of retail investors. The results suggest that, rather than searching for information on potential stocks to buy (Barber & Odean, 2008), retail investors are searching for information to resolve uncertainty about household FEARS (Da et al., 2015) during the COVID-19 crisis.

Investor Attention and Global Market Returns during the COVID-19 Crisis

The financial market response to the COVID-19 pandemic provides the first example of a market crash instigated by a health crisis. The crisis provides a unique setting in which to examine the market response to changes in investor attention. We utilise Google search volume (GSV) as a proxy for investor attention. GSV for the “coronavirus” keyword increases substantially from late-February and peaks in mid-March before declining substantially. Our results are broadly consistent with Da et al. (2015), indicating that GSV is primarily a proxy for the attention of retail investors and confirming that investor attention negatively influences global stock returns. A rise in the number of internet searches during the COVID-19 crisis induces a faster rate of information flow into financial markets and so is also associated with higher volatility. The identified relationships are economically and statistically significant even after controlling for the number of new COVID-19 cases and various macroeconomic effects. Increases in GSV have less impact on government bond yields, with Italian yields rising with investor attention. The more limited role of GSV is likely due to lower participation of retail investors in bond markets. The results suggest that, rather than searching for information on potential stocks to buy (Barber and Odean, 2008), retail investors are searching for information to resolve uncertainty about household FEARS (Da et al., 2015) during the COVID-19 crisis.

The Fed's Response to Economic News Explains the “Fed Information Effect”

High-frequency changes in interest rates around FOMC announcements are a standard method of measuring monetary policy shocks. However, some recent studies have documented puzzling effects of these shocks on private-sector forecasts of GDP, unemployment, or inflation that are opposite in sign to what standard macroeconomic models would predict. This evidence has been viewed as supportive of a “Fed information effect” channel of monetary policy, whereby an FOMC tightening (easing) communicates that the economy is stronger (weaker) than the public had expected. We show that these empirical results are also consistent with a “Fed response to news” channel, in which incoming, publicly available economic news causes both the Fed to change monetary policy and the private sector to revise its forecasts. We provide substantial new evidence that distinguishes between these two channels and strongly favors the latter; for example, (i) regressions that include the previously omitted public economic news, (ii) a new survey that we conduct of Blue Chip forecasters, and (iii) high-frequency financial market responses to FOMC announcements all indicate that the Fed and private sector are simply responding to the same public news, and that there is little if any role for a “Fed information effect”.

Expectation Dispersion, Uncertainty, and the Reaction to News

Releases of key macroeconomic indicators are closely watched by financial markets. We investigate the role of expectation dispersion and economic uncertainty for the stock-market reaction to indicator releases. We find that the strength of the financial market response to news decreases with the preceding dispersion in expectations about the indicator value. Uncertainty, in contrast, increases the response. We rationalize our findings in a model of imperfect information. In the model, dispersion results from a perceived weak link between macroeconomic indicators and fundamentals that reduces the informational content of indicators, while higher fundamental uncertainty makes this informational content more valuable.

Does doing good lead to doing better in emerging markets? Stock market responses to the SRI index announcements in Brazil, China, and South Africa

This paper investigates whether and how emerging markets reward firms’ corporate social responsibility (CSR) performance. We focus on the socially responsible investment (SRI) index, which lists the top CSR performers and serves as a tool to help investors make investment decisions based on financial and social criteria. We empirically test the financial market responses to the announcements of pioneering SRI indices recently launched in Brazil, China, and South Africa. We find that inclusion on an SRI index in these markets is associated with positive abnormal returns. However, inclusion on an SRI index does not benefit all firms equally: the positive financial response is strengthened by R&D expenditures but weakened by advertising expenditures; it is stronger for firms that have expanded globally to developing countries than those to developed countries.

Is ECB Monetary Policy More Powerful During Expansions?

This paper tests whether the effects of ECB monetary policy vary over different phases of the business cycle. It uses local projections to estimate the state-dependent impulse responses of economic activity and prices to monetary policy shocks. These are identified through high-frequency financial market responses after Governing Council meetings. While the impact of monetary policy on economic activity is roughly similar during recessions and expansions, prices respond more strongly during booms. The result holds when the state of the economy is based on measures of resource utilization, rather than on GDP growth rates. Nominal wages also respond more strongly to monetary policy during expansions and when there is no slack in the economy. The empirical findings are consistent with the presence of downward rigidity on nominal wages.

The “Standard Error” of Event Studies: Lessons from the 2016 Election

The 2016 Election offers an unusually stark warning about the limitations of event studies. In four separate pre-election event windows, financial market responses to shifts in electoral probabilities were consistent with expectations that a surprise Trump win would lead the S&P 500 to fall by 11 percent. The initial decline that accompanied Trump's win was more than reversed on the day after the election, however, suggesting a reassessment of its expected effect. We discuss explanations for this reassessment. But our broader point is methodological: today's event study may not reveal tomorrow's market expectation.

Financial Market Responses to a Natural Disaster: Evidence from Local Credit Networks and the Indian Ocean Tsunami

Conventional wisdom in economics holds that traditional credit and insurance networks are inapt for insuring against covariate risks such as natural hazards. We challenge this claim by examining changes in financial allocations in Rotating Savings and Credit Associations (Roscas), a popular group-based financial institution world-wide, in the aftermath of the 2004 Indian Ocean tsunami. With financial data from locations along the South Indian coast that were affected by this natural disaster to different extents, we estimate the causal effect of this devastating economic shock on financial flows between occupational groups, the price of credit and other loan characteristics. We find that the supply of funds in these local credit networks remained remarkably stable, while demand by self-employed members increased significantly. In response, substantial funds were channeled from wage-employed members and commercial investors to small and medium-scale entrepreneurs. We conclude that traditional non-market financial institutions may be more important for coping with covariate risks in low-income environments than commonly assumed.

Financial market response to extreme events indicating climatic change

A variety of recent extreme climatic events are considered to be strong evidence that the climate is warming, but these incremental advances in certainty often seem ignored by non-scientists. I identify two unusual types of events that are considered to be evidence of climate change, announcements by NASA that the global annual average temperature has set a new record, and the sudden collapse of major polar ice shelves, and then conduct an event study to test whether news of these events changes investors’ valuation of energy companies, a subset of firms whose future performance is closely tied to climate change. I find evidence that both classes of events have influenced energy stock prices since the 1990s, with record temperature announcements on average associated with negative returns and ice shelf collapses associated with positive returns. I identify a variety of plausible mechanisms that may be driving these differential responses, discuss implications for energy markets’ views on long-term regulatory risk, and conclude that investors not only pay attention to scientifically significant climate events, but discriminate between signals carrying different information about the nature of climatic change.

Risk-on/Risk-off: Financial market response to investor fear

This paper examines the relationship between changes in the level of investor fear (measured by VIX) and financial market returns. We document a statistically significant relationship, across asset classes, consistent with a flight to quality as investor fear increases. As VIX increase there is a decline in stock markets, bond yields, and high-yielding currencies (AUD and NZD), while the USD appreciates. Returns become more sensitive to changes in the level of investor fear during the financial crisis of 2008–09, when investor fear spikes sharply. Analysis of market returns subsequent to periods of extreme levels of investor fear suggests some predictive ability for future returns, and it is suggested that this may be used to develop a profitable trading strategy. Taken together, the results confirm that financial market returns are closely related to prevailing levels of investor fear.

Risk-On/Risk-Off: Financial Market Response to Investor Fear

This article examines the relationship between changes in the level of investor fear (measured by VIX) and financial market returns. We document a statistically significant relationship, across asset classes, consistent with a flight to quality as investor fear increases. As VIX increase there is a decline in stock markets, bond yields, and high-yielding currencies (AUD and NZD), while the USD appreciates. Returns become more sensitive to changes in the level of investor fear during the financial crisis of 2008-09, when investor fear spikes sharply. Analysis of market returns subsequent to periods of extreme levels of investor fear suggests some predictive ability for future returns, and it is suggested that this may be used to develop a profitable trading strategy. Taken together, the results confirm that financial market returns are closely related to prevailing levels of investor fear.

Electoral Violence and Securities Market Responses During the 2013 Pakistan General Election: Political Risk Metrics for the Rest of Us

The efficient-market hypothesis holds that securities markets are efficient, fair and instantaneous in their treatment of material information flows. The reality may be somewhat messier in the emerging traded asset markets of the Global South. Emerging markets, notably Pakistan, present particularly esoteric market information systems. In general, stock and corporate bond market actors gauge future corporate profits and sell assets when negative news announcements threaten future earnings. For their part, sovereign bonds sell off when the overall economic conditions of the national issuer appear to be threatened. Together, stock and bond markets amount to a massive crowd-sourcing mechanism for assessing and acting on political risk. Both academicians and policy practitioners have yet to fully appreciate the risk-assessment function played by markets. This paper will assess financial market responses to reports of electoral violence during the important 2013 general election in Pakistan. The election is used herein as an event study to assess how stock and bond traders responded to confirmed acts of political violence during and just after the campaign. Insights into both the theoretical efficacy of the efficient-market construct, as well as the particularities of Pakistan at this point in its long democratic journey, will be assessed.

International Financial Spillovers to Emerging Market Economies: How Important are Economic Fundamentals?

We assess the importance of economic fundamentals in the transmission of international shocks to financial markets in various emerging market economies (EMEs). Our analysis covers the so-called taper-tantrum episode of 2013 and six earlier episodes of severe EME-wide financial stress since the mid-1990s. Cross-country regressions lead us to the following results: (1) EMEs with relatively better economic fundamentals suffered less deterioration in financial markets during the 2013 taper-tantrum episode. (2) Differentiation among EMEs set in quite early and persisted throughout this episode. (3) Controlling for economic fundamentals, we also find that, during the taper tantrum, financial conditions deteriorated more in those EMEs that had earlier experienced larger private capital inflows and greater exchange rate appreciation. (4) For earlier episodes, we find little evidence of investor differentiation across EMEs being explained by differences in their relative vulnerabilities during EME crises of the 1990s and early 2000s. (5) That said, differentiation across EMEs based on fundamentals does not appear to be unique to the 2013 episode. Differences in economic fundamentals played a role in explaining the heterogeneous EME financial market responses during the global financial crisis of 2008, and the role of fundamentals appeared to progressively increase through the European crisis in 2011 and subsequently the 2013 taper tantrum.

Macroeconomic News Announcements, Systemic Risk, Financial Market Volatility and Jumps

This paper studies financial market volatility and jump responses to macroeconomic news announcements. Based on two decades of high-frequency data, we finds that there are significantly more jumps on news days than on no-news days, with the bond market being more responsive than the equity market, and nonfarm payroll employment being the most influential news. Both the first moment of news surprises and the second moments of disagreement and uncertainty affect financial market responses, with their impact significance changing over different market and response types. Market responses to news vary with economic situations, financial systemic risk and the zero-lower-bound policy.

International Financial Spillovers to Emerging Market Economies: How Important Are Economic Fundamentals?

We assess the importance of economic fundamentals in the transmission of international shocks to financial markets in various emerging market economies (EMEs). Our analysis covers the so called taper-tantrum episode of 2013 and six earlier episodes of severe EME-wide financial stress since the mid-1990s. Cross-country regressions lead us to the following results: (1) EMEs with relatively better economic fundamentals suffered less deterioration in financial markets during the 2013 taper-tantrum episode. (2) Differentiation among EMEs set in quite early and persisted throughout this episode. (3) Controlling for economic fundamentals, we also find that, during the taper tantrum, financial conditions deteriorated more in those EMEs that had earlier experienced larger private capital inflows and greater exchange rate appreciation. (4) For earlier episodes, we find little evidence of investor differentiation across EMEs being explained by differences in their relative vulnerabilities during EME crises of the 1990s and early 2000s. (5) That said, differentiation across EMEs based on fundamentals does not appear to be unique to the 2013 episode. Differences in economic fundamentals played a role in explaining the heterogeneous EME financial market responses during the global financial crisis of 2008, and the role of fundamentals appeared to progressively increase through the European crisis in 2011 and subsequently the 2013 taper tantrum.

Monetary Policy Shock and Financial Market Responses: An Empirical Study of Exchange Rate, Gold and International Equity Market

The asset pricing behavior around Rate Decision of The Central Bank is both an important and interesting Economic phenomenon. Predicting the direction and level of asset prices are important activities in the real world practice for investors. In this paper, I applied the Linear, Non-linear and Time Series methods to estimate the short term price change of several financial markets after the rate decision of FOMC in U.S. Fed by examine the data from 1990 to 2013. Our finding is that part of the asset pricing behavior is predictable conditional on the information set of rate decision. The unexpected part of hiking and cutting of benchmark overnight interest rate have significant influence on some asset classes. In the linear estimation parts, I found that the 1 basis point unexpected cut of the Fed Fund rate by the Fed Reserve in U.S. will drive 11 ticks rise of gold prices with significant level of 0.01. In the non-linear estimation parts, if the Fed Reserve cut its interest rate unexpectedly by 125 basis points, the probability that the Japanese Yen rises will be about 0.91, gold price rises will be about 0.80, the HangSeng Index rises will be 1.00, and the TSE rises will be about 0.98. My results are consistent with the hypothesis of rational behavior of economic agents in financial market and the related theory such as UIP(Uncovered Interest Rate Parity), Gold price as a prediction of inflation and international transmission of monetary policy through equity market.

When Do Language Wrappers Matter? Market Reactions to Language Use in Earnings Announcements

While the linkage between firms’ announcement of corporate quarterly earnings and stakeholder reactions has been widely studied, much less is known about the possible impact of adding specific language to those earnings numbers. We draw on research in organization theory and behavioral finance to advance an original perspective on the nature of the financial market response to language use. Specifically, we analyze theoretically and empirically how financial market participants are likely to respond to the use of positive tone, causal attribution and time orientation in corporate quarterly earnings announcements. We highlight markets’ differential response to language relative to both organizational performance and overall market sentiment. We test and find general support for our predictions on the value of language using extensive data on 648 quarterly earnings announcements from NASDAQ- listed firms in bull and bear markets (1999 and 2002).

Identification and Inference Using Event Studies

We discuss the use of event studies in macroeconomics and finance, arguing that many important macro‐finance questions can only be answered using event studies with high‐frequency financial market data. We provide a broad picture of the use of event studies, along with their limitations. As examples, we study financial markets' responses to specific events that help address questions such as the slope of bond demand functions and the efficacy of central bank liquidity programs. We also study the change in financial market responses to news in payrolls and unemployment in response to former Fed Chairman Greenspan's statement that payrolls are more informative.

Eliciting Substance from ‘Hot Air’: Financial Market Responses to EU Summit Decisions on European Defense

AbstractThe results of deliberations in multilateral fora are often considered ineffective. Decision making in the European Union (EU) and in particular its key intergovernmental body, the European Council, poses no exception. Especially in the domain of EU foreign and security affairs, the unanimity requirement governing this institution allegedly allows nationalist governments to torpedo any attempt to build up a credible European defense force and a unified foreign policy stance. In this article, we take issue with the claim that multilateral summits merely result in “hot air” by looking at whether and how decisions made during EU summit meetings affect the European defense industry. We argue that investors react positively to a successful strengthening of Europe's military component—a vital part of the intensified cooperation within the European Security and Defense Policy (ESDP)—since such decisions increase the demand for military products and raise the expected profits in the European defense industry. Our findings lend empirical support to the view that financial markets indeed evaluate the substance of European Council meetings and react positively to those summit decisions that consolidate EU military capabilities and the ESDP. Each of the substantial council decisions studied increased the value of the European defense sector by about 4 billion euros on average. This shows that multilateral decisions can have considerable economic and financial repercussions.