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Political uncertainty and financial market reactions: A new test

Author

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  • Wang, Huiqiang
  • Boatwright, Annie L.

Abstract

Recent literature highlights the crucial role of understanding the mechanism between political uncertainty and financial market reactions. Along the lines of this topic, our study stresses a clear causal framework. Exploiting one unique natural experiment of the Taiwan Strait Crisis (1995-96), we provide a simple testing strategy which could precisely quantify the effects of political shocks on stock markets. This approach combines the features of one innovative panel estimator and new statistical learning methods for causal inference. Our results indicate, separating true signal from noise via the optimal benchmark, the political crisis had a substantial and significant negative impact on Taiwan's stock prices. This finding is consistent with the empirical evidence of risk premium in recent studies. Moreover, the optimal counterfactual could be an alternative option for the ceteris paribus assumption in non-lab controlled settings. Finally, this study shows predictor selection is needed for a convincing causal estimate in counterfactual studies.

Suggested Citation

  • Wang, Huiqiang & Boatwright, Annie L., 2019. "Political uncertainty and financial market reactions: A new test," International Economics, Elsevier, vol. 160(C), pages 14-30.
    • Handle: RePEc:eee:inteco:v:160:y:2019:i:c:p:14-30
    DOI: 10.1016/j.inteco.2019.07.004
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    Cited by:

    1. Linhai Zhao & Ehsan Rasoulinezhad & Tapan Sarker & Farhad Taghizadeh-Hesary, 2023. "Effects of COVID-19 on Global Financial Markets: Evidence from Qualitative Research for Developed and Developing Economies," The European Journal of Development Research, Palgrave Macmillan;European Association of Development Research and Training Institutes (EADI), vol. 35(1), pages 148-166, February.
    2. Junchao Zhang & Wei Han, 2022. "Carbon emission trading and equity markets in China: How liquidity is impacting carbon returns?," Economic Research-Ekonomska Istraživanja, Taylor & Francis Journals, vol. 35(1), pages 6466-6478, December.

    More about this item

    Keywords

    Causal inference; Financial markets; Risk premium; Uncertainty;
    All these keywords.

    JEL classification:

    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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