Global production linkages and stock market co-movement

Summary

Focus

How do the forces of globalisation make asset returns move together ("asset return co-movement")? Although real economic integration via trade linkages should play an important role in making international equity markets fluctuate together, it has proven challenging so far to demonstrate this empirically. We revisit the role of real integration as an economically significant driver of international asset return co-movement by drawing on insights from the literature on global value chains (GVC), overturning some of the previous findings in this literature.

Contribution

From a data set on GVCs, we construct a new data set of novel measures of intermediate and final trade intensity which according to our theoretical framework should matter for the co-movement of profits and hence stock prices. In comparison with more aggregate measures of trade interlinkages examined in prior work, our novel angle is to study real interconnectedness via these granular bilateral measures and to show how international trade matters for stock market dynamics in the presence of reciprocal production linkages.

Findings

With our new measures, we provide evidence of a strong link between changes in real integration – in particular via GVCs – and equity market co-movement. This also holds when controlling for financial openness and other factors that could confound the role of real openness. First, we show that there are substantial differences between our novel measures of intermediate and final trade intensity and traditional openness measures, such as the ratio of exports and imports to GDP. Second, we find bilateral stock market co-movement to be related to trade integration measured by granular input-output linkages and value added of trade. Third, real integration explains equity market correlation well even when controlling for time trends, country characteristics, socioeconomic ties, and measures of financial integration.

Abstract

Although real integration conceptually plays an important role for the comovement of international equity markets, documenting this link empirically has proven challenging. We construct a new dataset of theory-guided, relevant measures of bilateral trade in final and intermediate goods and services. With these measures, we provide evidence of a strong link between changes in real integration – in particular global value chains – and equity market comovement. This also holds when controlling for financial openness and other factors that could confound the role of real openness. These results suggest that supply chain disruptions, for instance due to political tensions and the COVID-19 crisis, might also affect the interconnections between stock markets via rippling through the global production network.

JEL classification: F10, F36, F65, G10, G12, G15.

Keywords: financial integration, global value chains, international asset pricing, international trade, real integration, spillovers, stock market comovement, supply chains.