Effect of the U.S.--China Trade War on Stock Markets: A Financial Contagion Perspective

TL;DR

This study analyzes how the U.S.--China trade war impacts stock markets through financial contagion, developing a novel jump-diffusion model and identifying shifts in contagion channels using high-frequency data.

Contribution

It introduces a new jump-diffusion process to model risk contagion and proposes hypothesis tests for structural breaks in contagion channels.

Findings

Evidence of financial contagion from the U.S. to China.

Shift in contagion channel from integrated volatility to negative jump variation.

Development of a quasi-maximum likelihood estimator for the model.

Abstract

In this paper, we investigate the effect of the U.S.--China trade war on stock markets from a financial contagion perspective, based on high-frequency financial data. Specifically, to account for risk contagion between the U.S. and China stock markets, we develop a novel jump-diffusion process. For example, we consider three channels for volatility contagion--such as integrated volatility, positive jump variation, and negative jump variation--and each stock market is able to affect the other stock market as an overnight risk factor. We develop a quasi-maximum likelihood estimator for model parameters and establish its asymptotic properties. Furthermore, to identify contagion channels and test the existence of a structural break, we propose hypothesis test procedures. From the empirical study, we find evidence of financial contagion from the U.S. to China and evidence that the risk contagion channel has changed from integrated volatility to negative jump variation.