The causal effect of political risk on the stock market: Evidence from a natural experiment

Abstract By using the misfired missile event from Taiwan to mainland China as an exogenous shock, we identify the causal effect of potential military risk on the Chinese A‐share market. We find that the misfired missile event indeed causes a significant decline in the stock prices of Taiwan‐related A‐share firms, especially for firms that have stronger relationship with Taiwan. Further analysis shows that the increased required rate of return due to higher political uncertainty is the main driving force of the stock price decline. Our findings provide strong support for the existence of priced political risk in the stock market.