by Gertjan Verdickt (University of Antwerp)
This paper was presented at the EHS Annual Conference 2019 in Belfast.
One of the most severe events that affect stock markets is arguably a war. Because wars rarely occur, it is difficult to document what the effect of an increase in the threat and act of war is. Going back to history can go a long way to fill this gap.
In my research, I start by collecting a large sample of articles from the archives of The Economist to create the metrics, Threat and Act. This sample contains 79,568 articles from the period January 1885 to December 1913. To mimic investors and understand the content of news items, I rely on a textual analysis with a thorough human reading.
First, I document that Threat is a good predictor for actual events. If The Economist writes more about a potential military conflict, the probability of that conflict actually happening in the future is higher.
The other metric, Act, only captures conflicts that are happening right now. This suggests that, in contrast to what other historians find, The Economist did not write about war excessively but chose their war news coverage appropriately.
Second, I focus on seven countries with stock listings on the Brussels Stock Exchange: Belgium, France, Germany, Italy, Russia, Spain and the Netherlands. These countries are important for Belgium, either through import and export or with a large number of stock listings in Brussels.
Additionally, I use information on other European and non-European countries with stock listings in Brussels to test whether war risk could be considered a European or global form of risk.
For the seven countries, I document that firms do not adjust dividend policies when there is an increase in the threat of war, but only when there is an outbreak of war.
Investors, on the other hand, sell their stocks when there is an increase in the potential and outbreak of a military conflict. When the threat is not followed by an act, stock prices adjust increase to the similar levels as before.
But when there is an outbreak of war, stock returns are negative up to 12 months after the initial increase. This shows that war risk is priced appropriately in stock markets, but that the outbreak of war is associated with higher uncertainty and welfare costs.
More interestingly, I show that there is a decrease in stock prices for other European countries, but no effect for non-European countries. This suggests that investors value the importance of proximity to a war. But firms from these countries do not adjust their dividend policy when threat and act increase.