Abstract
Our study is the first to examine the pricing effect of U.S. trade policy uncertainty (TPU) on Chinese stocks. We estimate the U.S. TPU beta, which measures Chinese stock exposure to the U.S. TPU index. Both portfolio analyses and cross-sectional regressions suggest a significantly negative relation between the U.S. TPU beta and expected returns, which cannot be explained by other pricing factors. The stocks in the lowest U.S. TPU beta quintile can generate 3.48% higher annual returns compared to stocks in the highest U.S. TPU beta quintile. Furthermore, we provide two potential mechanisms that include a real economy channel and a behavioral finance channel using vector autoregression models. Our results indicate that the negative premium can be explained by both demanding more of high TPU beta stocks in hedging against adverse effects from TPU and selling more of low TPU beta stocks due to pessimistic beliefs of noise trader.
