9. u.s. TRADE BALANCE, PROTECTIONISM, AND JAPANESE ...

9. u.s. TRADE BALANCE, PROTECTIONISM, AND JAPANESE EQUITY PRICES: INTERNATIONAL INFLUENCE OF NATIONAL MACROECONOMIC NEWS

RAJ AGGARWAL The Edward j. and Louise E. Mellen Chair and Professor

of Finarue, John

Ca"oll University, Cleveland, Ohio

44118

DAVID C. SCHIRM Associate Professor of Economics and Finance, John Ca"oll University, Cleveland, Ohio 44118

ABSTRACT

This paper provides new evidence of the international influence of national macroeconomic news. It is documented that announcements of U.S. trade balances significantly influence equity prices for a number of Japanese industry groups especially in the second half of the 1980s. Larger than expected US. trade deficits and, perhaps, the associated higher probabilities of protectionist activities in the US., are associated with lower stock prices for Japanese firms in export oriented industries. The opposite effects are observed for Japanese firms in domestic industries with higher US. trade deficits indicating their possibly higher relative international competitiveness. These findings of a differential industry influence of US. trade balance announcements on Japanese stock prices have important implications for portfolio diversification, international asset pricing, trade negotiations, and other policies for international economic coordination. INTRODUCTION

There is increasing interest in the international impact of economic news especially as international trade, investment, and other linkages have increased and barriers to the international flow of funds have fallen in most markets. Further, with the rapid and increasingly efficient dissemination of economic news and other shocks across financial markets, there is now greater interest in the international impact of national economic news. In addition, economic news is being seen as an important source R. Aggarwal (ed,), RESTRUCTURING JAPANESE BUSINESS FOR GROWTH. Copyright © 1999, Kluwer Academic Publishers, Boston, All rights reserved,

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II. Japanese Financial Environment

of asset price volatility and, therefore, as an important factor in asset pncing Since even the use of multi-index and other variants of the capital asset pricing model have failed to account fully for the many anomalies and regularities in asset prices (Fama, 1991; Jacobs and Levy, 1988; and Lakonishok and Smidt, 1988). However, the international impact of macroeconomic announcements, except U.S. money supply announcements, has not received much attention. For example, while the influence of US. trade balance announcements on US. asset prices and the dollar/yen exchange rate has been investigated previously, their international impact has not been examined even though there is significant evidence that such impact may be quite important. Persistent trade imbalances in the 1980s seem to have contributed to the difficult and contentious relations between the US. and Japan, the two largest economies in the world. It has been contended that the Japanese trade surplus with the US. has been harmful to the US. economy with such charges often leading to calls for protectionist measures by the US.! The debate on this topic has been shrill and vociferous in both countries and can benefit from empirical evidence on the valuation effects of US. trade imbalances on both US. and Japanese asset prices. Thus, this study fills an important gap in the literature as it examines the affects of US. trade balance announcements on the current and future profitability of Japanese industries as reflected in their equity prices. It provides evidence that for the second half of the 1980s, announcements of US. trade balances significantly influenced stock prices for selected Japanese industry groups. Larger US. trade deficits, and perhaps the associated higher likelihood of protectionist activities in the US., are associated with lower stock prices for Japanese firms in export oriented industries. The opposite effects are observed for Japanese firms in domestic industries with higher US. trade deficits indicating their higher relative international competitiveness. These results should be of interest to scholars, managers, and policy makers as they may have important implications not only for international asset pricing models and international portfolio diversification, but also for assessing and developing policies for international economic coordination and trade negotiations. The rest of this paper is organized as follows. International impact of news considers prior research regarding the international influence of economic news, including the influence of news in the trade balance and other macroeconomic announcements, on asset prices. Research methodology and data outlines the data sources and research methodology used for our empirical tests, empirical results presents and discusses our results, and the paper ends with some conclusions in the last section. 1 For example, Gagnon and Rose (1991) contend that during 1962-1988 the trade deficit between japan and the US. in specific goods has been remarkable persistent and there is no tendency for the trade to balance. Butler (1991) surveys a number of studies and also concludes that U.S.-Japanese trade has no tendency to balance. Therefore, U.S.-Japan economic relations are likely to continue to be heavily influenced by their trade balance. The popular and business press also often relates trade deficits with protectionism in the U.S. For details see, for example, Thomson, Robert. "Japan Fears US. Anger as Trade Surplus Surges "Financial Times, December 12, 1991, pp. 16; Farnsworth, Clyde, "Tougher Stance is Taken by US. on japan Trade" New York Times, january 5, 1991, p. AI, A14; and Schlesinger, Jacob M., " U.S. Chip Makers Find Quotas Help Them Crack Japan's Market" Wall Street Journal, December 20, 1990, p. AI, A4.

9. International Influence of National Macroeconomic News

163

INTERNATIONAL IMPACT OF NEWS IN THE U.S. TRADE BALANCE

Trade Balance News and Asset Prices: There have been many studies of the influence of macro-economic announcements on asset prices in the U.S. 2 Unlike information on auction market variables such as interest rates, exchange rates, or equity and financial futures prices, current values of variables like the trade balance are not observable by economic agents. The trade balance announcement may reflect useful new information about the supply and demand for domestic currency in foreign exchange markets and the performance of the domestic economy in a global context. Thus, information contained in balance of trade announcements can be useful in assessing the performance of the real but contemporaneously unobservable sector of the economy. Under these conditions of imperfect information, such news may be useful to a wide range of economic agents including private businesses, individuals, central banks, and other public institutions. Consequently, the asset price impact of news in trade balance announcements depends on the reactions not only of private economic agents but also of central banks. Information in such announcements can be useful in formulating business plans, consumption decisions, and in assessing the economic effects of central bank activities, attitudes, and abilities to manage monetary aggregates, interest rates, and inflationary expectations (Duck, 1984). For example, central banks may react to trade balance announcements by making portfolio adjustments or by using the news to guide their activity (such as open market operations and intervention in currency markets). It has also been contended that the trade balance and the current account affect international net asset positions and, therefore, consistent with rational expectations, changes in such balances can be expected to influence prices of various assets. U.S. trade balance deficits have been associated with current account deficits and capital account surpluses. This implies an increase in the domestic stock of interest-bearing assets associated with trade deficits. Thus, ceteris paribus, trade deficits can be expected to be associated with decreases in the prices of such assets. 3 In addition, decreases in the prices of interest-bearing assets imply increases in their yields and decreases in stock prices. These influences seem to have been particularly important in the 1980s. Hardouvelis (1988) examined the influence of news in a number of macroeconomic series, including the trade balance, on exchange rates and interest rates for the period 1980-84. He found that unanticipated trade balance figures have a significant influence only on a short-term interest rate and only for the 1980-82 subperiod. Deravi, Gregorowicz, and Hegji (1988) examined the influence of trade balance , Surveys by Sheehan (1985) and Hafer (1986) have documented the numerous studies of the influence of money supply announcements on interest rates, exchange rate~, and eq uity prices. Tandon and Ulrich (1987) examined th e effects of money supply and inflation announcements on many interest and exchange rate series and found that news regarding the former variables significantly influence only some interest rates. J For details of the theoretical relationships and models of the influence of th e trade balance and the current account see, for example. Duck (1984), Frankel and Muss. (1985), Kouri (1976, 1983), and Pappel (1986). However, Stockman (1988) shows that both positive and negative relationships between th e balance of payments and the exchange rate are possible in theory.

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announcements on spot and forward rates for six major currencies for the period 1980-87. They found significant influences only for the post-1985 period. Aggarwal and Schirm (1992) and Klein et al. (1991) document the influence of U.S. trade balance announcements on asset prices in the U.S. and show that this influence has become increasingly important in the post-1985 time period. There is also some empirical evidence that news in the balance of trade influences asset betas (Abell and Krueger, 1989) and is priced in tests of the arbitrage pricing theory (Bodurtha, Cho, and Senbet, 1989). International Influence of Macroeconomic Announcements: The international influence of national macro economic news is also starting to receive attention. King and Wadhwani (1990), Koch and Koch (1991), Kasa (1992), Roll (1992), Aggarwal and Park (1994), and Lin et al. (1994), among others, have documented the increasing international influence of innovations in equity markets. Reflecting the importance of the U.S. economy, Cheung and Kwan (1992) note that investors elsewhere look to the U.S. market for leadership and economic information. Husted and Kitchen (1985) document that a widening of the deviation of German and Canadian interest rates from interest parity is associated with U.S. money supply announcements. Roley (1987) examines the impact of U.S. money supply announcements on the yen/dollar exchange rate and finds evidence that the Japanese fmancial markets are segmented. Bailey (1990) extends this research to a number of Pacific Rim countries and finds that international responses to U.S. money supply announcements depend on the openness of an economy to international trade and investment. Trade balance news may also impact asset prices through exchange rates (Mukherjee and Naka, 1995; Engle, Ito, and Lin, 1990) find that intra-daily changes in the yen/dollar exchange rate is consistent with the meteor shower hypothesis (i.e., markets in different countries react simultaneously to news or shocks) and, Aggarwal and Schirm (1992) and Wakita (1989) show that U.S. trade balance announcements influence the yen/dollar exchange rate in the U.S. and in Tokyo. In contrast, Pruitt and Wei (1991) examine, but do not find significant, the influence of U.S. trade balance announcements on prices of the few Japanese ADRs (American Depository Receipts) listed in the U.S. Japanese Impact of Us. Trade Balance Announcements: Anecdotal and other evidence (press reports and personal discussions with market participants) indicates that financial market participants in Japan await and react to U.S. trade balance announcements and, on such days, most traders in Tokyo stay later at their desks till after the announcement in the U.S. (because of time differences, it is 10.30pm in Tokyo when it is 8.30am in Washington). Nevertheless, there has been no prior empirical study of the influence of the U.S.-Japan trade imbalances on equity prices in various Japanese industries. As discussed earlier, unexpectedly large trade deficits can be expected to be associated with decreases in prices of domestic assets and increases in domestic interest rates. Asset price effects of trade balance news in countries with trade surpluses and deficits are expected to be opposite in sign, so that U.S. trade deficits can be


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expected to be associated with Japanese trade surpluses and consequent increases in Japanese stock and bond prices. 4 Thus, we hypothesize that: Hal: Japanese domestic industry stock prices should increase with larger US. trade deficits. Importance of the Industry and the Politics Factors: Industries differ with regard to firm concentration, barriers to entry and exit, degree of foreign competition through trade and direct investment, price elasticities, cost of capital, and with regard to technological sensitivity and composition of their costs (Sundarsanam, 1992). All of these aspects of industry structure influence a firm's ability to pass through changes in exchange rates and insulate its profitability from associated changes in the markets for its inputs and outputs. Thus, inflation and exchange rate changes are likely to have a differential impact on the profitability of companies in different industries. s It seems that for many purposes, the industry factor may even be more important than a firm's country of origin. In a recent paper, Roll (1992) documents that the industry classification of a firm is more important than its location in developing a well diversified international portfolio. Consequently, news in trade balance announcements reflecting changes in expected future profitability because of changes in exchange rates, input costs, and output prices would be reflected differentially in the equity prices of companies in different industries (Jorion, 1990; and Markus, 1986). Trade balance announcements may provide new information about the directly unobservable relative international competitiveness of various industries. For Japanese industries with significant dependence on exports, US. trade balance announcements may convey significant information about the probability of protectionist measures being enacted in the US. There seems to be some evidence of politics in Japan and the US. influencing the other country's economy. Azrak and Wynne (1995) document that Japanese foreign direct investment in the US. is influenced by threats of protectionism. Ito (1991) documents that US. elections are preceded by higher levels of economic stimulus in Japan. Edwards and Ostry (1990) show that the influence of the trade balance on employment and exchange rates depends on anticipated protectionist policies. Nollen and Iglarsh (1990) indicate that the possibility of protectionist votes in the US. Congress is related to the size of the trade deficit and Hogan et al. (1991) document that the influence of the trade deficit on the yen/dollar exchange rate depends on the threat of Another hypothesis that could be consistent with rising equity prices for Japanese export-oriented industries in the presence of larger than expected U.S. trade deficits, links such deficits to relatively stronger real economic growth in the U.S. as compared to her major trading partners. While our statistical analysis canoO[ distinguish this effect from the other effects that we have suggested, it should be recognized that during the 1985-1990 period covered by our study, this issue is unlikely to be of much concern as real economic growth for the U.S. averaged 2.7%, while real economic growth averaged 4.5% for japan, 3.3% for Germany, and 2.9% for Canada (annual growth of real gross domestic product). s Ries (1993) shows that the profits and stock prices of japanese auto assemblers and large parts manufacturers rose as a resu1t of voluntary export restraints of 1981. For additional details on the differential effects of inflation and international events see, Bodnar and Gentry (1993), Flannery and james (1984) , Mann (1986), and Pearce and Roley (1988). 4

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protectionist activity in the us. It can be expected that prices of Japanese companies, particularly those that are heavily dependent on exports to the US., would be affected negatively by unexpectedly large US. trade deficits and any associated higher probability of US. protectionist action. Thus, we contend: H,2: Japanese export-oriented industry stock prices should decrease with larger US. trade deficits. However, given the ability and inclination to hedge against exchange rate, political, and operating risks, and that the profitability of Japanese industries depends only somewhat on business with the US., it remains an empirical question if equity prices of Japanese industries are on balance still significantly influenced by US. trade balance announcements. Findings of significance for such an influence associated with US. trade balance announcements would be particularly noteworthy especially since only the net effect after hedging activity can be observed empirically. As this brief discussion indicates, in this study we hypothesize that unexpectedly larger US. trade deficits can normally be expected to be associated with higher relative competitiveness and, thus, higher stock prices of Japanese companies. However, for export oriented Japanese industries, unexpectedly larger US. trade deficits can be expected to be associated with lower stock prices of such Japanese companies especially if these deficits result in a significantly higher probability of U.S. protectionist actions. RESEARCH METHODOLOGY AND DATA

Research Methodology: The purpose of this paper IS to measure the reaction of Japanese industry stock indexes to new monthly information on the U.S. trade balance during the 1980s. Following a conventional assumption of financial market efficiency, only new information on the trade balance at the time of the monthly announcement should affect financial asset prices. We first regress daily percentage changes in the industry stock price indexes on the daily percentage changes in the TOPIX index using equation (1): (1)

where DP lt and DP Mt represent the daily percentage changes in the TOPIX industry and overall TOPIX indexes, respectively. The residuals from the estimation of equation (1) reflect changes in industry returns after accounting for economy-wide systematic macroeconomic factors. Next, these residuals for each Japanese industry are examined for the influence of u.S. trade balance announcements. We assess market reaction to unexpected trade balance announcements using equations of the following form: DP,+t = b o + btUTB, + e,

(2)

where DPt+h the dependent variable for business day t+ 1, represents excess returns for each industry as measured by the residuals from equation (1). Each percentage


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change in asset price is measured using the first daily closing price after the announcement less the last daily closing price prior to the announcement, i.e., the Japanese return on calendar day t+ 1 is regressed on the news in the trade balance released on calendar day t in the US. as the Japanese equity markets for day t have already closed when the US. trade balance is announced at 8.30am EST (Japanese time is 14 hours ahead of EST). The independent variable in all regression estimates of equation (2) is the unexpected monthly US. trade balance announcement i.e., UTB, is the unexpected component of the monthly US. trade balance announcement on day t and e, is a random error term. 6 The unexpected announcement (UTB,) is calculated as the actual trade balance announcement (ATB,) less the trade balance expected by market participants (ETB,). UTB, = ATB, - ETB,

(3)

During the period covered by this study the US. trade balance was negative. All expected and actual trade balance measures are included as negative values in calculating the unexpected trade balance announcement used in the estimated regressions. We recognize that equation (2) is a reduced form equation measuring market response to new information on the trade balance and that there are a number of possible scenarios consistent with market attention to this particular announcement. According to prior literature we should not, a priori, expect other types of daily news that may hit the market to be correlated with the unexpected independent variables (Hardouvelis, 1988). Thus, our empirical estimations of equation (2) are intended to provide statistical evidence of the significance of market response only to U.S. trade balance announcements. Finally, in order to examine the differential impact of US. trade balance announcements on equity prices of different Japanese industries and to test our second hypothesis, the b 1 coefficients estimated for each industry from equation (2) are regressed cross-sectionally as dependent variables against the ratios of exports to output (the export dependence ratio) for these industries as independent variables/ i.e., (4)

where b i and ERi are the estimated equation (2) coefficient and the export ratio for industry i respectively. According to our second hypothesis, C1 should be significant and positive, indicating that equity prices of Japanese industries can (, The mean unexpected trade balances were not signifICantly different from zero for the periods examined in this study and were characterized by a random normal distribution (with means and standard deviations ranging from -0.07 to -0.72 and 1.47 to 2.82 respectively). The actual trade balance announcement ranged from -$19.22 billion to -$0.32 billion with a mean and standard deviation of - $8.66 and $4.60 billion, respectively. The expected trade balance announcement ranged from -$16.00 billion to - $1.50 billion with a mean and standard deviation of -$8.38 and $4.30 billion, respectively. For the period studied, trade imbalances with Japan consistently reflected the largest proportion of the overall u.s. trade deficit. 7 This regression includes the export oriented Japanese industries as per page 117 of the Bank of Japmt Monetary and Economic Studies for January 1990. These industries are listed in the first column in tables 1 and 2.

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be expected to decline more significantly when the u.s. trade deficit is larger than expected if a larger proportion of that industry's output is exported. Role if International Exchange Rate Regimes: The effects of u.s. trade balance announcements on Japanese companies may also depend on the exchange rate policy regime in effect for the time period being examined. Trade imbalances have become significant and politically sensitive particularly in the late 1980s. 8 The late 1980s were also characterized by significant changes in exchange rates and international agreements to coordinate economic policies, agreements that may also influence the effects of u.S. trade balance announcements on Japanese companies. Central bank use of news in the trade balance may be influenced both by the nature of their domestic policy goals and by international agreements for monetary cooperation. Since the mid-1980s, the focus of Federal Reserve policy objectives seems to have shifted somewhat to emphasize international issues. Management of the international value of their currency also seems to have become a policy objective for the major central banks especially since the "Plaza Agreement" in 1985 and the Louvre Accord in 1987. 9 News in the trade balance seems to have become increasingly important as a source of information that can be used to guide and coordinate central bank intervention in domestic and currency markets. 10 This means that the effects of u.s. trade deficits on Japanese equity prices should be examined with the data segmented by the dates of these international policy coordination agreements. Data: Economic sector and industry group daily stock price indexes are taken from the Japanese Security Research Institute (JSRI) data base for the Tokyo Stock Price Index (TOPIX) as well as the TOPIX indices for 28 Japanese industries for the October 1, 1985 to August 31, 1990 period. Estimates of the expected component of the trade balance announcement (ETB,) are taken from Money Market Services Inc's monthly survey median forecast of the u.S. merchandise trade balance. Consistent with other such studies of the economic impact of the U.S. trade balance (e.g., Aggarwal and Schirm, 1992 and Klein et a!., 1991), we divided the overall period into two subperiods to reflect different international economic policy coordination and exchange rate regimes: October 1985-February 1987, and March 1987-August 1990. The 1985 and 1987 breaks correspond to the Plaza Agreement and the Louvre Accord among the G-5 and G-7, respectively. 11 The Plaza It A review of the New York Times for the 1980s indicates a significant increase in the number of artic1es on the trade balance from an average of 23 per year before 1985 to an average of 34 per year after 1985. A similar increase from 15 per year to 24 per year is noted for stories in the Wall Street Journal. ') Hardouvelis (1984) provides empirical evidence that the influence of the news in money supply announcements on interest and exchange rates changed with the Federal Reserve operating policy change in October 1979. Ito (1987) found that the nature and distribution of intradaily exchange rate changes varied with changes in cooperative agreements among the "Group of Five" central banks. Ito and Roley (1987) and Makin and Sauer (1986) document differences across Federal Reserve operating regimes in the yen/dollar rate response to economic news. 10 For a review of the growing literature on government intervention in foreign currency markets see, for example. Humpage (1986). Further, the influence of the Japanese yen on other Asian currencies seems to be increasing in recent yea rs (e.g .. Aggarwal and Mougoue. 1996). 11 These periods are consistent with the periods used in the recent studies of Hardouvelis (1988), and Deravi, Gregorowicz. and Hegji (1988). Heller (1988) and others review the order in which policy variables appear in the FOMe directive and contend that the management of foreign exchange rates received high priority in the Federal Reserve policy making following the Louvre Agreement. As indicated by Heller (1988) and others, during the 1982- 85 period the external performance of the U.S. economy seems not to have been a focus of Federal Reserve policy making. Also see Klein et al. (1991) for additional evidence supporting the time period breakdowns used in this study.


169

Agreement by the G-S countries recognized the need for US. dollar depreciation relative to the currencies of major US. trading partners. In addition, the G-5 countries agreed that stimulative (restrictive) aggregate demand polices were necessary in countries with surplus (deficit) trade balances. The 1987 Louvre Accord recognized that stabilization of short term fluctuations in dollar foreign exchange rates through central bank foreign exchange market intervention were collectively desirable for the G-7 countries, as payments imbalances among these countries were reduced. These periods also coincide with trend differences in dollar/yen exchange rates and protectionist sentiment in the United States. EMPIRICAL RESULTS

The regression results reported in Table 1 provide some evidence in support of our first hypothesis as they indicate evidence of significant equity price increases for domestic Japanese industries in response to news of larger US. trade deficits during the 1985-87 period. 12 Export dependent Japanese industries are listed in the first column of Table 1 (and Table 2) in order of their export dependence ratio. The Japanese industries with significantly positive coefficients in Table 1 are the highly export oriented industries, such as electrical machinery and preCISIOn equipment, where unexpectedly large US. trade deficits are associated with declining stock prices. As expected, equity prices of Japanese industries that are not highly export dependent are not influenced by US. trade balance announcements. Interestingly, three of the five coefficients that are significant are negative and belong to industries that are mainly domestic: Real Estate, Land Transportation, and Warehouse. These negative coefficients indicate that unexpectedly large US. trade deficits Oapanese surpluses) are associated with positive excess returns (industry returns residuals after accounting for market-wide effects) for domestic Japanese industries. 13 These results provide some support for our second hypothesis with regard to the impact of potential protectionist actions by the United States. 14 For the 1987-90 period, the regression results reported in Table 2 provide somewhat better support for both our hypotheses. In this period, many of the coefficients, including five of seven that are significant, are positive. 1s A positive coefficient in this table indicates that decreases in stock prices of those Japanese industries are 12 Inclusion of the expected trade balance in the estimated regressions does not influence the sign or significance of the estimated coefficients on the unexpected trade balance. Similarly, when ·the regressions are done with all days and we include day-of-the-week dummy variables in addition to UTB, we obtain lower regression R-squares with no change in the significance of the results. Only the results using the announcement days only are presented in this paper. \3 Separate regression results for equation (2) for the period February 198(}-September 1985 are not presented here but are available from the authors. In this period the only Japanese industries that are sensitive to news in the U.S. trade balance announcements are the fisheries, agriculture. and forestry industries. However. while the coefficient is positive, its significance. the F-value. and the R- squared are all low. This lack of significance during the 1980-85 period may reflect the insignificance of the trade imbalance between the two countries. These results are also consistent with prior studies of interest rate and exchange rate response to trade balance announcements in the U.S. (HardouveJis, 1988 and Tandon and Ulrich, 1987). 14 The evidence presented in Table 1 is consistent with similar findings for the U.S. , as unexpectedly large U.S. trade balance deficits were associated with lower stock prices in the U.S. during this period. See Aggarwal and Schirm, 1992. 15 Statistical stability tests of the regression coefficients, not presented here for brevity, confirm this conclusion (the results are available from the authors). Re-estimating equation (2) for the overall 1985-1990 period improves the results but not significantly.

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Table 1. Japanese Industry Stock Price Adjustment to U.S. Trade Balance News (9/85-2/87; N = 15) B: Other Industries

A: Export Dependent Industries#

TRN PRC EMA MAC lAS CHM TEX MET GAC PAP OIC FOD

UTB

t-ratio

AR2(%)

DW

0.08 0.25** 0.25* 0.02 -0.18 -0.08 -0.10 -0.10 0.07 0.03 0.07 -0.06

0.59 2.10 2.59 0.38 -1.30 -0.92 -1.56 -1.10 1.12 0.27 0.41 -1.03

-4.9 19.6 28.9 -6.5 4.7 -1.1 9.3 1.4 1.8 -7.1 -6.3 0.4

1.21 2.07 2.17 2.25 2.22 1.91 1.65 1.26 1.59 1.70 1.55 2.08

BAI CON WAS REE LDT NFR MIN OMP COM MRT AIT CUM EAG SER RUB FAF

UTB

t-ratio

AR'(%)

DW

-0.01 -0.13 -0.22* -0.31** -0.26** 0.06 0.07 0.05 -0.04 -0.13 0.18 -0.05 -0.04 -0.02 0.03 -0.03

-0.16 -0.71 -2.59 -2.08 -1.92 0.65 0.43 0.47 -0.93 -0.90 1.00 -0.54 -0.43 -0.20 0.85 -0.19

-7.5 -3.7 28.9 19.3 16.1 -4.3 -6.2 -0.59 -0.9 -1.3 0.1 -5.4 -6.2 -7.4 -7.4 -7.4

2.32 1.78 2.14 1.20 1.77 2.08 1.01 1.84 1.94 2.21 2.92 2.13 1.60 1.89 2.07 2.54

# == Industries with significant export dependence as per Bank (~f japmJ Mtltletary and Economic Studies, January 1990, p. 117; listed in order of export dependence. *, ** == signifICant at 5% and t 0% levds All..' ; adjusted R ' BAI ; Banking and Insurance Index OW == Durbin Watson Statistic UTB ; unexpected trade balance CON = Construction Index TRN == Transportation Equipment Index WAS == Warehouse Index PRe == Precision Instrument Index REE ; Real Estate Index EMA ; Electrical Machinery Index LOT == Land Transportation Index MAC ; Machinery Index NFR = Nonferrous Metals Index lAS ; Iron and Steel Index MIN ; Mining Index CHM ; Chemicals Index OMP ; Other Manufacturing Index TEX ; Textile Index COM = Commerce Index MET ; Metal Products Index MRT = Marine Transportation Index GAC ; Glass and Ceramics Index AfT == Air Transportation Index PAP ; Pulp and Paper Index CUM == Communication Index OIC ; Oil and Coal Index EAG ; Ele ctric and Gas Index FOD ; Foods Index SEll.. ; Service Index RUB ; Rubber Products Index FAF ; Fisheries, Agriculture and Forestry

associated with unexpectedly large u.s. trade deficits. Interestingly, again, these Japanese industries-machinery, electrical machinery, transportation equipment, and precision equipment-also have significant dependence on exports. Once again as expected, equity prices of Japanese industries that are not highly export dependent are not influenced by U.S. trade balance announcements. The industries with significant negative coefficients in Table 2, construction and banking and insurance, are once again primarily domestically oriented. 16 While the statistical results presented in Tables 1 and 2 may not at first seem par](, While the data on fisheries do not indicate export rkpendence. it is a globally integrated industry with prices influenced by co nsumption in the U.S. and by the international value of the U.S. dollar. Thus, it is not surprising that the fisheries coefficient is significantly positive.


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Table 2. Japanese Industry Stock Price Adjustment to U.S. Trade Balance News (8/87-8/90; N = 39) A: Export Dependent Industries#

TRN PRC EMA MAC lAS CHM TEX MET GAC PAP OIC FOD

B: Other Industries

UTB

t-ratio

AR'(%)

DW

0.21* 0.32* 0.37* 0.15* 0.19 0.05 0.07 0.07 0.02 -0.12 -0.15 -0.12

2.35 2.22 2.81 2.07 1.39 0.80 0.84 0.76 0.28 -1.29 -1.1 8 -1.31

10.6 9.4 15.4 7.9 2.4 -1.0 -0.9 -1.1 -2.5 1.7 1.0 1.8

1.74 2.25 2.34 1.99 1.60 2.08 1.89 2.27 1.23 1.99 1.61 1.30


# == Industries with significant export dependence as per Balik p. 117; listed in order of export dependence.

,1Japafl

UTB

t-ratio

AR'(%)

DW

-0.14* - 0.15** 0.02 -0.10 -0.16 0.05 -0.18 0.05 0.04 0.28 0.12 -0.05

-2.85 -1.77 0.26 -0.98 -1.55 0.44 -0.95 0.69 0.76 1.65 0.91 -0.40 0.09 -0.11 1.00 2.00

15.8 5.3 -2.5 -0.1 3.6 -2.2 -0.3 -1.4 -1.1 4.4 -0.5 -2.3 -2.7 -2.7 0.1 7.3

1.97 2.46 2.57 1.91 1.98 2.14 1.91 2.03 2.30 2.19 1.96 2.28 2.26 1.68 1.84 2.33

O.ot -O.ot

0.14 0.19**

Monetary and Economic Studies, January 1990,

*.** = significant at 5% and 10% levels AR' OW UTB TRN PRe EMA MAC lAS CHM TEX MET GAC PAP OIC FOD

= adjusted R' = Durbin Watson Statistic = unexpected trade balance = Transportation Equipment Index = Precision Instrument Index = Electrical Machinery Index = Machinery Index = Iron and Steel Index = Chemicals Index = Textile Index = Metal Products Index = Glass and Ceramics Index = Pulp and Paper Index = Oil and Coal Index = Foods Index


= ;;;; = = ;;;; = = = = = = :;;;; = = = =

Banking and Insurance Index Construction Index Warehouse Index Real Estate Index Land Transportation Index Nonferrous Metals Index Mining Index Other Manufacturing Index Commerce Index Marine Transportation Index Air Transportation Index Communication Index Electric and Gas Index Service Index Rubber Products Index Fisheries, Agriculture and Forestry

ticularly strong for many of the Japanese industries examined here, further consideration suggests that in fact these are important findings. Given the ability and inclination to hedge against exchange rate, political, and operating risks, and that the profitability ofJapanese industries depends only somewhat on business with the US., it is notable that equity prices of some Japanese industries are still significantly influenced by US. trade balance news. Further, these relationships between the sensitivity of a Japanese industry to US. trade balance announcements and its dependence on foreign trade is confirmed by estimates of equation (4) represented by the following OLS regressions of the unexpected trade balance coefficients from Tables 1 and 2 on the proportion of the total output exported for various Japanese industries:

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1985-87: bi

= -0.074 + 0.008ER (-0.67)

1987-90: b i

= -0.077 + 0.014ER (-0.82)

Adj. R2

= 36.6%

Adj. R2

= 71.8%

(2.40)* (50.52)*

where b i represents the trade balance coefficients form Tables 1 and 2. ER are export ratios (exports/output) for the industries in Tables 1 and 2 (t-values are given in parentheses and *indicates significance at the 5% level). According to our second hypothesis, Cl should be significant and positive, indicating that equity prices of Japanese industries can be expected to decline more significantly when the US. trade deficit is larger than expected if a larger proportion of that industry's output is exported. These estimates of equation (4), especially for the 1987-1990 period, support our second hypothesis. Thus, the results presented in this study are consistent with the two alternative hypotheses stated earlier. They show that news in the US. balance of trade announcements has a significant influence on the excess returns of some Japanese industries (industry return residuals after accounting for market-wide effects) in the second half of the 1980s. This time period coincides with the increased size and political sensitivity of US. trade deficits after the 1985 Plaza Agreement and the 1987 Louvre Accord. Given the ability and inclination to hedge against exchange rate, political and operating risks, and the limited dependence of the profitability of Japanese industries on business with the US., it is quite remarkable that equity prices of any Japanese industries are significantly influenced by US. trade balance announcements. Further, as expected, the influence of US. trade balance announcements on equity prices of Japanese industries seems to depend on the extent of their export orientation. The greater decline in equity prices of export oriented industries associated with higher US. trade deficits seems to be consistent with the increased political sensitivity of US. trade deficits in the second half of the 1980s. The announcement effect is positive for domestic industries, possibly reflecting their higher relative competitiveness. Further, the size of the Japanese industry equity response to the US. trade balance varies directly with its export/output ratio. These results have important policy and practical implications. For example, based on the reaction of the stock market documented here, Japanese industries that are highly export dependent should support and take actions to reduce the possibilities of politically motivated trade sanctions related to higher US. trade deficits. These results also suggest that it may be useful to include information in foreign trade balance data in testing asset pricing models not only for industries with significant global business but also for companies that may do business only domestically. CONCLUSIONS

This paper provides fresh evidence of the international impact of national economic news. This study documents that news in the U.S. balance of trade announcements significantly influences equity values for Japanese industries in the second half


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