Effect of the U.S.–China Trade War on Stock Markets: A Financial Contagion Perspective

Abstract

  In this article, to model risk contagion between the U.S. and China stock markets based on high-frequency financial data, we develop a novel continuous-time jump-diffusion process. For example, we consider three channels for volatility contagion—such as integrated volatility, positive jump variation, and negative jump variation—and each stock market is able to affect the other stock market as an overnight risk factor. We develop a quasi-maximum likelihood estimator for model parameters and establish its asymptotic properties. Furthermore, to identify contagion channels and test the existence of a structural break with a known structural break date, we propose hypothesis test procedures. Using the proposed diffusion model with high-frequency financial data, we investigate the effect of the U.S.–China trade war on stock markets from a financial contagion perspective. From the empirical study, we find evidence of financial contagion from the United States to China and evidence that the risk contagion channel has changed from integrated volatility to negative jump variation.