Firm‐level exposure to trade policy shocks: A multidimensional measurement approach

• Published date: 01 September 2024
• Author: Giovanni Bruno,Felix Goltz,Ben Luyten
• Date: 01 September 2024
• DOI: http://doi.org/10.1111/eufm.12473

DOI: 10.1111/eufm.12473

ORIGINAL ARTICLE

Firm‐level exposure to trade policy shocks:

A multidimensional measurement approach

Giovanni Bruno

1

|Felix Goltz

1,2

|Ben Luyten

3

1

Scientific Beta, Nice, France

2

EDHEC Business School, Nice, France

3

Scientific Beta, London, UK

Correspondence

Felix Goltz, Scientific Beta, 400

Promenade des Anglais, 06200 Nice,

France.

Email: felix.goltz@scientificbeta.com

Abstract

We propose a firm‐level measure of exposure to trade

policy shifts that combines characteristics (tradability

of goods, share of output exported and corporate risk

disclosures) with information from stock returns. We

show that the measure reliably captures out‐of‐sample

differences in price responses and sentiment related to

trade tensions, both in US and international data.

Differences across firms are economically important

with return effects of 140 bp around tariff announce-

ments. We argue that such a multidimensional

measure is a useful tool for future research on trade

policy risk.

KEYWORDS

equities, exposure measurement, international trade, risk

exposures, trade policy

JEL CLASSIFICATION

F13, G10

Eur Financ Manag. 2024;30:2135–2163. wileyonlinelibrary.com/journal/eufm

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This is an open access article under the terms of the Creative Commons Attribution‐NonCommercial‐NoDerivs License, which permits

use and distribution in any medium, provided the original work is properly cited, the use is non‐commercial and no modifications or

adaptations are made.

© 2023 The Authors. European Financial Management published by John Wiley & Sons Ltd.

We would like to thank Paul Schweigl and Chaoping Zhang for excellent research assistance. We thank Noël Amenc,

Daniel Aguet and two anonymous referees for helpful comments and suggestions that greatly improved the quality of

this paper.

1|INTRODUCTION

Trade policy influences the financial performance of firms. It affects the cost and availability of

foreign inputs, access to export markets and the extent of foreign competition. Shifts in trade

policy will have heterogeneous effects across firms (e.g., Fajgelbaum et al., 2020). For example,

more productive firms tend to thrive with trade liberalisation while less productive firms

benefit from protectionism (Bernard et al., 2006; Melitz, 2003).

This paper analyses a firm‐level measure of exposure to shifts in trade policy and documents

it captures substantial heterogeneity across firms in their reaction to trade policy shifts. This

measure combines multiple dimensions of trade policy exposure and exploits information in

stock return covariance in addition to industry and firm characteristics. We show in detailed

validation tests that the measure captures heterogeneous exposure of firms to trade policy

shocks in terms of both stock price reactions and sentiment or uncertainty on trade policy.

Importantly, the measure is available ex‐ante at the firm level and effectively captures

heterogeneous responses ex‐post. We also show that the measure is not subsumed by

information contained in standard firm classifications into size categories or industries.

Such a measure can be used in several academic and practical applications. For example,

the impact of changes in trade policy needs to be well understood by policy makers. The

exposure measure allows to identify which areas of the economy will benefit or suffer from

proposed changes. Furthermore, accurate measurement of exposure to shifts in trade policy is

needed in asset pricing research to test whether this is a priced risk. It also allows to construct

investment portfolios that enable investors to manage trade policy risk, be it to harvest a

potential premium or to hedge undesired exposures in nontradable components of their wealth.

Previous research has used several measures to capture firms' exposures to shifts in trade

policy. Barrot et al. (2019) use shipping costs for a firm's goods, following Bernard et al. (2006),

to measure exposure to globalisation. High shipping costs are structural economic barriers that

decrease the potential for international trade. This low tradability will make it less likely for a

firm to sell its goods internationally. Therefore, firms producing products with high shipping

costs, or low tradability, are less exposed to international trade flows and the risk of shifts in

trade policy. Furthermore, Tian (2018) distinguishes between firms based on the proportion of

their output that is exported. Firms which export a larger fraction of their output are more

exposed to changes in international trade policy. Yet another approach to capture exposure to

shifts in trade policy is to use textual analysis of a firm's risk disclosures (see Baker et al., 2016;

Caldara et al., 2020). A firm's management could indicate themselves that the firm is exposed to

the risk of the introduction or removal of trade barriers.

We propose a multidimensional measure of exposure to shifts in trade policy by combining

these three individual measures.

1

Furthermore, we also include information about stock return

covariances. Stock returns allow to capture relevant firm‐level information based on the

assessment of market participants. Stocks with a high exposure according to this measure are

expected to perform well when trade barriers decrease, so we call them trade peace stocks.

1

We note that it could be desirable for some applications to omit certain components of our measure. For example,

textual analysis that identifies stocks exposed to trade policy risk will lead to false positives that can be easily identified

by human analysts. Even if such a measure adds information on average, occurrence of false positives might not be

acceptable for investors who conduct an analysis of their portfolio holdings. This could motivate removing the textual

analysis component in investment applications.

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