TSE‐484 April 2014 “The Cost of Political Tension: An Anatomy” Yinghua He, Ulf Nielsson and Yonglei Wang The Cost of Political Tension: An Anatomy Yinghua Hea Ulf Nielssonb Yonglei Wanga April 2014 Abstract The paper examines how increased political tension affects stock returns and identifies the channels through which this occurs. Focusing on Taiwan’s sovereign debate, we find that non-violent events harming the political relationship with mainland China are associated with an average daily drop of 200 basis points in Taiwanese stock returns. Expectations of mild tension also adversely affect stock returns. The impact is stronger on firms located close to potential conflict zones and on Taiwanese firms openly supporting the pro-independence party. The adverse effect on political opponents concentrates on those firms economically exposed to mainland China through either investments or exports. JEL classification: F51, G14, G15 Keywords: political tension, political connections, China, Taiwan Acknowledgements: We are grateful for valuable comments from Augustin Landier, Harminder Singh, Shang-Jin Wei, Qing Xia and participants at seminars at Toulouse School of Economics, University of Iceland, the 21th SFM conference in Taiwan, 2013 World Finance & Banking symposium in Beijing and 2013 Econometric Society China Meeting. a Toulouse School of Economics, E-mail:
[email protected];
[email protected]. b Copenhagen Business School, Department of Finance. Email:
[email protected] 1 1 Introduction While it has been documented that physical violence in political disputes can negatively impact asset prices (e.g. Abadie and Gardeazabal, 2003; Zussman and Zussman, 2006; Besley and Mueller, 2012), other cost factors of political tension have largely been left unexplored.