Geopolitical risk, economic policy uncertainty and asset returns in Chinese financial markets

Abstract

Purpose: This paper investigates the impact of a change in economic policy uncertainty (Formula presented.) and the absolute value of a change in geopolitical risk (Formula presented.) on the returns of stocks, bonds and gold in the Chinese market. Design/methodology/approach: The paper uses Engle's (2009) dynamic conditional correlation (DCC) model and Chiang's (1988) rolling correlation model to generate correlations of asset returns over time and analyzes their responses to (Formula presented.) and (Formula presented.) Findings: Evidence shows that stock-bond return correlations are negatively correlated to (Formula presented.), whereas stock-gold return correlations are positively related to the (Formula presented.) but negatively correlated with (Formula presented.) This study finds evidence that stock returns are adversely related to the risk/uncertainty measured by downside risk, (Formula presented.) and (Formula presented.), whereas the bond return is positively related to a rise in (Formula presented.) ; the gold return is positively correlated with a heightened (Formula presented.). Research limitations/implications: The findings are based entirely on the data for China's asset markets; further research may expand this analysis to other emerging markets, depending on the availability of GPR indices. Practical implications: Evidence suggests that the performance of the Chinese market differs from advanced markets. This study shows that gold is a safe haven and can be viewed as an asset to hedge against policy uncertainty and geopolitical risk in Chinese financial markets. Social implications: This study identify the special role for the gold prices in response to the economic policy uncertainty and the geopolitical risk. Evidence shows that stock and bond return correlation is negatively related to the ΔEPU and support the flight-to-quality hypothesis. However, the stock-gold return correlation is positively related to |ΔGPR|, resulting from the income or wealth effect. Originality/value: The presence of a dynamic correlations between stock-bond and stock-gold relations in response to (Formula presented.) and (Formula presented.) has not previously been tested in the literature. Moreover, this study finds evidence that bond-gold correlations are negatively correlated to both (Formula presented.) and (Formula presented.)