Abstract
We study stock market reactions to large international military conflicts since World War II. Using a news analysis proxy for the estimated likelihood that a conflict will result in a war, we find that an increase in the war likelihood tends to decrease stock prices, but the ultimate outbreak of a war increases them. In cases when a war starts surprisingly, however, the outbreak of a war decreases stock prices. We show that this puzzle cannot be explained by risk or ambiguity aversion or by expectations about a quick end of the war.
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Notes
Standard predictive models are often constructed such that changes in variables at time \(t + 1\) are explained by changes in variables at time t. In our case, this approach would require to use a variable for the war likelihood which realizes prior to actual changes in the stock market. However, since our argument is to use the news proxy as a flexible probability measurement which is available for different wars over time, the functional forms used here slightly differ from standard models due to the delay of news publication. This, however, does not alter the models’ predictive power.
Also, the error correction parameter γ is significantly negative as expected for both types of probability measurements.
That is, the data set ranges from \(\tilde{t} - 25\) to \(\tilde{t} + 25\) days around \(\tilde{t}\).
We use this type of structural break analysis since we are interested in whether there exists an instantaneous jump in the stock market index at the onset of a war. An alternative question would be whether there are possible changes in the trend of the stock market. For that purpose, a model testing for changes in expected growth rates of stock returns may be appropriate (see Amihud and Wohl 2004).
Note that the estimated structural break on March 18 coincides with the beginning of the US ultimatum to Saddam Hussein. Investors might have anticipated that this ultimatum would not be agreed upon which caused an early rise in stock market values.
CRS Report for Congress, Costs of Major U.S. Wars, July 2008.
The Gulf War is often also referred to as Second Gulf War or Persian Gulf War.
Although it would be interesting to see how stock markets evolved in the countries were war actually took place, this analysis is often not feasible. Either stock exchanges were not yet institutionalized or controlled by the government so that data would not be reliable, or data are not available.
Due to issues of data availability, we could not perform a similar analysis for global wars having occurred earlier in history.
Li and Sacko (2002) find that an unexpected onset of a military dispute reduces bilateral trades more severely.
This holds true unless we studied intra-day data which in most of these cases is not available.
For simplicity, we normalize the investor’s return for a “peace portfolio” to one in the case of a peaceful resolution.
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Acknowledgments
We thank our students Marco Lang, Laura Leoni, Raphael Müller, and Thomas Rast for their help with the data collection and analysis as well as Florian Herzog from swissQuant, Yakov Amihud, and Christian Ehm as well as anonymous referees for useful comments. Support by the National Centre of Competence in Research “Financial Valuation and Risk Management” (NCCR FINRISK), Project A1, “Behavioural and Evolutionary Finance,” and by the University Priority Program “Finance and Financial Markets” of the University of Zurich is gratefully acknowledged.
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Brune, A., Hens, T., Rieger, M.O. et al. The war puzzle: contradictory effects of international conflicts on stock markets. Int Rev Econ 62, 1–21 (2015). https://doi.org/10.1007/s12232-014-0215-7
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DOI: https://doi.org/10.1007/s12232-014-0215-7