The stock market reaction to the US-China tensions: Evidence from emerging and developed markets

Abstract

This paper examines the effect of US-China tensions on stock market volatility across developed and emerging economies using a newly developed US-China Tension (UCT) index. Employing both in-sample and out-of-sample predictability approaches, the study investigates whether UCT significantly explains variation in stock return volatility within the sample period, assesses the model’s explanatory power, and evaluates whether incorporating UCT improves predictions of future volatility beyond what is captured by geopolitical risk (GPR) alone. The findings reveal a positive relationship between UCT and stock market volatility. Further evidence from the multivariate panel data model suggests that the volatility effects associated with US-China tensions are short-lived, albeit with greater resilience for the emerging markets. Overall, the results highlight the global significance of these tensions and caution against rapid policy changes, as their impact may fade with time.