The causality link between political risk and stock prices

Huiqiang Wang

Journal of Financial Economic Policy, 2019, vol. 11, issue 3, 338-367

Abstract: Purpose - Prior studies have paid close attention to the impact of political risk on financial markets. Following this strand of literature, this paper aims to focus on the causality link between political shocks and their impacts on emerging stock markets. Design/methodology/approach - This paper highlights an innovative counterfactual model for political risk assessment. Based on a natural experiment, i.e. the Taiwan Strait Crisis in 1995-1996, this study utilizes one data-driven approach, e.g. the synthetic control methods (SCMs), to estimate causal impact of this political shock on Taiwan’s stock market. Findings - Major findings in this study are consistent with existing literature on the price of political risk, e.g. political uncertainty commands a risk premium. The SCM estimations suggest that Taiwan’s stock prices dramatically underperformed its newly industrialized peers and other developed markets during the crisis. The SCM results are statistically significant and robust to various cross-validation tests. Research limitations/implications - Findings in this study indicate that political risks could generate enormous impacts on emerging financial markets. In particular, political uncertainty following new geopolitical dynamics requires proper identification and assessment. Originality/value - To the author’s knowledge, this paper is the first rigorous counterfactual study to the causality relationship between political uncertainty and stock prices in emerging markets. This paper is distinct from previous studies in applying a data-driven approach to combine the features of learning from others (cross-sectional) and learning from the past (time series).

Keywords: International finance; Forecasting and simulation (search for similar items in EconPapers)
Date: 2019
References: Add references at CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
https://www.emerald.com/insight/content/doi/10.110 ... d&utm_campaign=repec (text/html)
https://www.emerald.com/insight/content/doi/10.110 ... d&utm_campaign=repec (application/pdf)
Access to full text is restricted to subscribers

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eme:jfeppp:jfep-07-2018-0106

DOI: 10.1108/JFEP-07-2018-0106

Access Statistics for this article

Journal of Financial Economic Policy is currently edited by Prof Franklin Mixon

More articles in Journal of Financial Economic Policy from Emerald Group Publishing Limited
Bibliographic data for series maintained by Emerald Support ().