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INTERNATIONAL SANCTIONS AND THEIR EFFECT ON THE STOCK MARKET Did International Sanctions Affect the Russian Stock Market during the Ukraine Crisis? Name: Iris Mulkens, MSc ANR: 232670 SNR: U1259073 Submission date: 24-11-2018 Supervisor: prof. dr. B.J.M. Werker Management Summary This paper investigates the effect of international sanctions on the Russian stock market during the Ukraine Crisis. International sanctions are defined as actions attempting to force another country into adjusting their behavior towards a desired behavior. In this study, they are sanctions that are declared by the US or the EU during the Ukraine crisis. A review of existing literature revealed that the Russian economy and the Russian stock market were impacted by the Ukraine crisis. The Ukraine Crisis had a negative impact on the Russian rouble, the amount of capital available and the interest rates. Combined, the negative impact on these factors also forced many Russian companies to limit their investment projects. This study’s empirical research investigated the effect of international sanctions on the Russian stock market. More specifically, the impact of Ukraine Crisis related international sanctions on the stock market’s price level and trading volume were studied. The first tests investigated whether abnormal returns on the Russian stock market in the event period, where the event period included the sanction announcement day, were significantly different from 0. These tests did not provide enough evidence to conclude that the Ukraine Crisis related international sanctions affected the price level of the Russian stock market. To check whether external factors influenced the tests, control variables were added to control for the day-of-the-week effect. The controlled tests did not lead to a different conclusion regarding the effect of international sanctions on the price level of the Russian stock market. Next, the effect of international sanctions on trading volume was tested. These tests revealed that international sanctions have a positive effect on trading volume. The effect became smaller for event windows that included more days after the announcement date. Sanction related events also had a positive effect on trading volume, though the effect was smaller and less significant. To control for the day-of-the-week effect, controlled tests on the effect of international sanctions on trading volume were also conducted. In the controlled environment, the effect increases compared to the uncontrolled tests’ results, but only very slightly. 1 Table of Contents Management Summary 1 Table of Contents 2 1. Introduction 3 1.1 Problem Indication 3 1.2 Research Question 3 1.3 Structure 3 2. Review of Current Literature 4 2.1 What are International Sanctions? 4 2.2 International Conflicts and their Effect on Stock Markets 4 2.3 International Sanctions and their Economic Influence 5 2.4 The Ukraine Crisis 5 2.5 Russia during the Ukraine Crisis 6 3. Methods 7 3.1. Research Design 7 3.2 Data Collection 7 3.3 Data Analysis 10 4. Results 14 4.1 Data description 14 4.2 Trading Volume Transformed 15 4.3 Testing Abnormal Returns 15 4.4 Testing Abnormal Returns Controlled 16 4.5 Testing Trading Volume 17 4.6 Testing Trading Volume Controlled 19 5. Robustness checks 22 5.1 Adding Restrictions on Estimation Window 22 5.1 Robust Regressions 24 6. Conclusion 27 6.1 Review of Current Literature Concluded 27 6.2 Empirical Study Concluded 27 6.3 Research Question Answered 28 6.4 Implications 28 6.5 Discussion 29 References 31 Appendix 33 ​ 2 1. Introduction 1.1 Problem Indication Sanctions against Russia during the Ukraine Crisis have contributed to a fast deterioration of the economic situation in Russia since 2014 (Nelson, 2015). As a result of the Ukraine Crisis and its international sanctions, Russia has seen accelerated capital flight. The Russian ruble has depreciated strongly and inflation has significantly increased. Though there have been other events that may have simultaneously affected the Russian economy, there is no doubt that international sanctions and the Ukraine Crisis have had a negative impact. Some researchers have studied the effects international sanctions have on their target’s economy. Others have focussed on the effects they have on other aspects of the target country. Additionally, there have been studies that looked at the effects international sanctions can have on the country that is imposing the sanctions. The effect of the Ukraine Crisis on Russia in general and the Russian economy specifically has also been studied by researchers. This study specifically aims to investigate the effect of international sanctions during this crisis, on the Russian stock market. 1.2 Research Question Given the large impact the Ukraine Crisis had on the Russian economy, the fact that it has affected the stock market is not surprising. But did the international sanctions individually affect the stock market? To investigate this in the case of Russia during the Ukraine Crisis, I propose to find an answer to the following question: What was the effect of international sanctions on the Russian stock market during the Ukraine Crisis? This research question will be investigated by looking at current literature on the topic. An empirical study will be used to explore the effect of Ukraine Crisis related international sanctions on the Russian stock market price level and on trading volume in the Russian stock market. 1.3 Structure The first step to answering the research question will be a review of current literature on international sanctions and the Ukraine Crisis. This will shed light on the effect of international sanctions on stock markets as well as financial and economic environments in general. It will also give a preliminary overview of the situation in Russia during the Ukraine Crisis. After this literature review, an empirical data analysis will examine the effect of international sanctions on the Russian stock market during the Ukraine Crisis specifically. First, the research methodology will be explained, after which the data analysis and its results will be presented. Finally, some steps that were taken to improve the reliability of the study will be explained and the research will be concluded. 3 2. Review of Current Literature 2.1 What are International Sanctions? International sanctions can broadly be defined as actions attempting to coerce another country into adjusting their behavior towards a desired behavior (Cranmer, Heinrich & Desmarais, 2014). In this definition, the desired behavior is behavior that is in line with international rules and laws and a state of peace and security (Ćwiek-Karpowicz & Secrieru, 2015). Sanctions are initiated by one or more international actors, who are called senders. They pursue these actions against one or more others, the receivers (Carter, 1988). The most important organ in terms of global peace and security is the Security Council, which is one of the principal organs of the United Nations (UN). It is their responsibility to determine the existence of a threat to peace or act of aggression. The Security Council will call upon peaceful settlement in case of a dispute. It may resort to imposing sanctions or even authorize the use of force to maintain or restore international peace and security (The Security Council, n.d.). Besides the UN Security Council, individual countries or groups of countries may also extend sanctions. Since the UN Security Council has strict protocols for imposing sanctions, the process can take quite long. Therefore, autonomous sanctions by individual countries or groups of countries may be used when the Security Council is not able to impose sanctions quickly enough or even at all. Two important autonomous entities who have declared sanctions against Russia in the Ukraine Crisis are the United States (US) and the European Union (EU). For the purpose of this study, international sanctions will be defined as sanctions that are declared by the Security Council, the US or the EU. The timing of a sanction will be determined by the official declaration date of the entity that has declared the sanction. 2.2 International Conflicts and their Effect on Stock Markets Typically, international sanctions are part of a wider international conflict. International sanctions are imposed to change a country’s behavior into a more favorable one. They are used to prevent the escalation of international conflicts into warfare or to support peace efforts in times of international conflict. International conflicts generally influence a country’s economy, which is an effect that scholars have tried to unravel for a long time. Schneider and Troeger (2006) have tried to find out how stock markets react to international conflict. They studied the influence of three large political conflicts on global financial markets; the Gulf war and subsequent international interactions with Iraq, the conflicts between Israel and the Palestinians and civil wars in ex-Yugoslavia. Their study was based on time-series analyses using daily stock market data. Their results show that within those specific war regions, global stock market reactions to international conflict are mostly negative. Brune, Hens, Rieger and Wang (2015) have found some less straightforward effects of international conflict on stock markets. These authors discovered that an increase in the probability of a war outbreak leads to decreasing stock prices, and a decrease in the likelihood of a war increases stock prices. 4 They also found that once a war begins, stock market prices do not decrease further and instead increase significantly. However, this was only true for anticipated war outbreaks. When a war that starts unexpectedly, its outbreak does decrease stock prices. These are just a few examples of stock market movements during international conflict and warfare. However, we are interested in the specific effect of international sanctions on stock market movements. We will now take a closer look at evidence of how international sanctions influence economies and stock markets globally.

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