TRADE WARS’ IMPACT ON STOCK MARKET CORRELATIONS - FROM THE US-CANADA TRADE WAR AND THE US-JAPAN TRADE WAR TO THE US-CHINA TRADE WAR

Abstract

This study looks at the correlations of stock market returns when two countries are in a trade war. We initiate investigations on daily closing indices in New York Stock Exchange, Toronto Stock Exchange, and Tokyo Stock Exchange. After generating return correlations with either DCC-MGARCH model or rolling window regressions, we test if there exists a disconnect in correlations on the day when trade wars begin. We also further test the results by various ways such as using data from Hong Kong Stock Exchange as control and adding the Gramm–Rudman–Hollings Balanced Budget and Emergency Deficit Control Act to the regressions. We find out that, even though no significant disconnect in market correlations spotted after the US-Canada trade war, the correlations of market returns show a significant drop after the US-Japan trade war. Finally, we apply the results found in previous two trade wars to the current US-China trade war after comparing different aspects of trade wars and predict that there should also be a disconnect in stock market return correlations within five years after the US-China trade war. The findings reconcile the mixed results found in prior research, and serve as a springboard for future researchers. We identify limitations of the current study and outline directions for subsequent research.