International trade network and stock market connectedness: evidence from eleven major economies

Abstract

Depth of cross-country international trade engagement is an important source of (the strength of) stock-market connectedness, depicting how directional attributes of trade determine the magnitude of spillover of stock returns across economies. We premise and test this hypothesis for a group of eleven major economies during 2000 m1-2021 m6 using both system-wide and directional evidence. We exploit the input–output network of Bilgin and Yilmaz (2018) to construct a trade-network, and use Diebold and Yilmaz's (2009, 2012, 2014) Connectedness Index to proxy for stock-market connectedness among economies. We reveal China's instrumental role in the trade-network and its rising influence in stock markets dominated by the US. Motivated by the fact that shocks on an economy's imports and exports may lead to different magnitude of stock market spillover to its trade partner, we further carry out a pairwise directional level investigation. Once the directional dimensions of both the trade flows and the stock market influences are considered, we find that an economy's stock return spillover to its trade partner is generated from its position as an importer and exporter. More importantly, being an importer is found to be a stronger source of such spillover than being an exporter.

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