Geopolitical risk, economic policy uncertainty and asset returns in Chinese financial markets

Abstract

Purpose

This paper investigates the impact of a change in economic policy uncertainty (ΔEPUt) and the absolute value of a change in geopolitical risk (|ΔGPRt|) on the returns of stocks, bonds and gold in the Chinese market.

Design/methodology/approach

The paper uses Engle's (2009) dynamic conditional correlation (DCC) model and Chiang's (1988) rolling correlation model to generate correlations of asset returns over time and analyzes their responses to (ΔEPUt) and  |ΔGPRt|.

Findings

Evidence shows that stock-bond return correlations are negatively correlated to ΔEPUt, whereas stock-gold return correlations are positively related to the |ΔGPRt|, but negatively correlated with ΔEPUt. This study finds evidence that stock returns are adversely related to the risk/uncertainty measured by downside risk,  ΔEPUt and  |ΔGPRt|, whereas the bond return is positively related to a rise in ΔEPUt; the gold return is positively correlated with a heightened |ΔGPRt|.

Research limitations/implications

The findings are based entirely on the data for China's asset markets; further research may expand this analysis to other emerging markets, depending on the availability of GPR indices.

Practical implications

Evidence suggests that the performance of the Chinese market differs from advanced markets. This study shows that gold is a safe haven and can be viewed as an asset to hedge against policy uncertainty and geopolitical risk in Chinese financial markets.

Social implications

This study identify the special role for the gold prices in response to the economic policy uncertainty and the geopolitical risk. Evidence shows that stock and bond return correlation is negatively related to the ΔEPU and support the flight-to-quality hypothesis. However, the stock-gold return correlation is positively related to |ΔGPR|, resulting from the income or wealth effect.

Originality/value

The presence of a dynamic correlations between stock-bond and stock-gold relations in response to  ΔEPUt and  |ΔGPRt| has not previously been tested in the literature. Moreover, this study finds evidence that bond-gold correlations are negatively correlated to both ΔEPUt and  |ΔGPRt|.

Citation

Chiang, T.C. (2021), "Geopolitical risk, economic policy uncertainty and asset returns in Chinese financial markets", China Finance Review International, Vol. 11 No. 4, pp. 474-501. https://doi.org/10.1108/CFRI-08-2020-0115