The Globalization Risk Premium

• Author: JULIEN SAUVAGNAT,ERIK LOUALICHE,JEAN‐NOËL BARROT
• DOI: http://doi.org/10.1111/jofi.12780
• Published date: 01 October 2019
• Date: 01 October 2019

THE JOURNAL OF FINANCE •VOL. LXXIV, NO. 5 •OCTOBER 2019

The Globalization Risk Premium

JEAN-NO ¨

EL BARROT, ERIK LOUALICHE, and JULIEN SAUVAGNAT∗

ABSTRACT

In this paper, we investigate how globalization is reflected in asset prices. We use

shipping costs to measure firms’ exposure to globalization. Firms in low shipping cost

industries carry a 7% risk premium, suggesting that their cash flows covary negatively

with investors’ marginal utility. We find that the premium emanates from the risk of

displacement of least efficient firms triggered by import competition. These findings

suggest that foreign productivity shocks are associated with times when consumption

is dear for investors. We discuss conditions under which a standard model of trade

with asset prices can rationalize this puzzle.

RECENT DECADES HAVEBEEN CHARACTERIZED by a high degree of trade integration.

This era of globalization1is generally seen in a positive light, as it has been

associated with more product variety at lower prices, cheaper intermediate

goods, and greater access for U.S. firms to foreign markets.2Yet globalization

also makes domestic economies more sensitive to foreign shocks. A salient

∗Jean-No¨

el Barrot is with HEC Paris and CEPR. Erik Loualiche is with the University of Min-

nesota, Carlson School of Management. Julien Sauvagnat is with Bocconi University and CEPR.

For helpful comments, the authors thank Stefan Nagel (the Editor); Nick Bloom; Maria Cecilia

Bustamante (discussant); Bernard Dumas (discussant); Nicola Gennaioli; Matthieu Gomez; Pierre-

Olivier Gourinchas; Tarek Hassan (discussant); Christian Julliard; Matteo Maggiori (discussant);

Jonathan Parker; Carolin Pflueger; Thomas Philippon; Nick Roussanov (discussant); Chris Telmer

(discussant); Adrien Verdelhan; Michael Weber (discussant); anonymous referees; and seminar

participants at MIT Sloan, SED annual meetings 2015, 2015 China International Conference in Fi-

nance, 2015 European Economic Association annual meetings, 2016 ASSA meetings, Spring 2016

NBER International Trade and Investment meeting, Spring 2016 NBER International Finance

and Macroeconomics meeting, 2016 NYU Stern Macrofinance conference, 2016 Duke–UNC Asset

Pricing Conference, Spring 2016 Macro-Finance Society Meeting, CEPR First Annual Spring Sym-

posium in Financial Economics, CEPR European Symposium in International Macroeconomics,

CSEF-IGIER Symposium on Economics and Institutions, NBER Summer Institute Asset Pricing

meeting, Yale,UC San Diego, University of Illinois Urbana–Champaign, Carnegie Mellon Univer-

sity, UT Dallas, Stockholm School of Economics, and HEC Paris for their valuable inputs. Julien

Sauvagnat gratefully acknowledges financial support from the Agence Nationale de la Recherche–

Investissements d’Avenir (ANR-11-IDEX-0003/Labex Ecodec/ANR-11-LABX-0047). Wewould like

to thank Vincent Tjeng for outstanding research assistance. The authors do not have any potential

conflicts of interest as identified in the Journal of Finance disclosure policy.

1While the focus of this paper is restricted to international trade flows, the term “globalization”

sometimes also encompasses economic and financial integration.

2See, for instance, Broda and Weinstein (2006) and Feenstra and Weinstein (2014) for product

variety at lower prices, Goldberg et al. (2010) and De Loecker et al. (2016) for cheaper intermediate

goods, and Lileeva and Trefler (2010) for access to foreign markets.

DOI: 10.1111/jofi.12780

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2392 The Journal of Finance R

example is China’s productivity growth, which has led to a dramatic increase

in its exports to the rest of the world and to the United States in particular,

with both gains for consumers, and negative consequences for manufacturing

employment and wages.3In short, globalization exposes domestic economies

to foreign shocks with heterogeneous effects on households and firms that

complicate the analysis of its overall impact.

In this paper, we study the effects of globalization through the lens of asset

prices. Assets’ exposure to macroeconomic shocks is reflected in risk premia.

We capture firms’ exposure to trade shocks and examine their effects on U.S.

investors’ marginal utility.Our approach relates to recent work that uses infor-

mation from asset markets to evaluate the effects of innovation and technologi-

cal change (see, for instance, Gˆ

arleanu, Panageas, and Yu(2012)). The intuition

is as follows: if the performance of firms exposed to international trade flows

covaries negatively with investors’ marginal utility, these firms will command

a risk premium. This is what we find empirically. This premium can be driven

either by a positive or a negative joint reaction of domestic firms’ performance

and households’ consumption to foreign shocks. Our evidence points to the lat-

ter and indicates that states of the world in which firms suffer from increased

import competition are states in which consumption is dear. In summary, for-

eign shocks are perceived as bad news by the marginal investor.

We measure firms’ exposure to globalization using shipping costs (SC). In

particular, we follow Bernard, Jensen, and Schott (2006b) and exploit import

data to compute the costs associated with shipments, called Cost-Insurance-

Freight, as a percentage of the price paid by importers. We document substan-

tial cross-sectional variation and time-series persistence in SC, consistent with

the idea that this proxy captures structural and slow-moving barriers to trade.

We also show that SC are tightly linked to shipments’ weight-to-value ratio,

and that both measures correlate negatively with firms’ propensity to import

and export, that is, with their exposure to globalization.

We next build portfolios of stocks based on quintiles of SC and analyze their

returns from 1975 to 2015. We find that the zero cost portfolio that is long

stocks in high SC industries and short stocks in low SC industries has aver-

age annual excess returns of −7% and a Sharpe ratio of 35%. To confirm that

this premium does not reflect loadings on well-known risk factors, we estimate

the residual of stock excess returns from the five-factor model of Fama and

French (2015). We find that the low SC portfolio has abnormal returns of 9.7%

annually, and that the high minus low SC portfolio generates negative excess

returns of 13.7% annually. These findings hold for U.S. and European stocks

considered separately, as well as for different subperiods in our sample. Impor-

tantly, they also hold when portfolios are value-weighted, which suggests that

foreign shocks matter for investors’ wealth. We do not find evidence, however,

that investors misunderstand the displacement effect of import competition in

a way that could create a wedge between ex post realized returns and ex ante

3See Amiti et al. (2018) for consumption gains and Pierce and Schott (2016), Autor, Dorn, and

Hanson (2013), and Acemoglu et al. (2015) for effects on employment and wages.

Globalization Risk Premium 2393

expected returns. In particular, we find no systematic differences in earnings

announcement returns for stocks with low and high SC. Moreover, equity ana-

lysts tend to correctly predict the effect of import competition on domestic U.S.

firms. We conclude that the risk of foreign shocks is priced in the cross-section

of expected returns, and that the performance of firms exposed to these shocks

covaries negatively with domestic investors’ marginal utility.

This finding can be interpreted as a positive response of consumption and

cash flows to foreign shocks through higher exports or sourcing opportunities.

Alternatively, this finding may be a negative response of consumption and

cash flows through the displacement of domestic firms by import competition.

We find evidence for the latter interpretation. First, the risk premium is con-

centrated among firms that are likely to suffer from import competition, but

unlikely to benefit greatly from increased export opportunities. Second, the

returns of firms in low SC industries load more negatively on a proxy for for-

eign productivity shocks, especially the returns of firms more likely to suffer

from import competition. Taken together, the results indicate that the price

of the risk of foreign shocks is negative, that is, that consumption responds

negatively to foreign shocks. Given the domestic benefits associated with for-

eign shocks, including gains from variety, lower prices, and enhanced export

opportunities, this finding is a puzzle. It suggests that the displacement risk

associated with foreign shocks outweighs the benefits from the perspective of

domestic investors.

We examine whether this puzzle can be rationalized within a standard two-

country dynamic general equilibrium model `

a la Melitz (2003). To do so, we

first derive the elasticity of domestic profits and the elasticity of export profits

to foreign productivity shocks. The former is negative due to price effects, and

amplified if demand elasticity is high, while export profits benefit from a rise in

demand in the foreign country,although this effect is dampened by the intensity

of competition in the foreign market. The response of domestic households’

utility to foreign productivity shocks trades off two competing effects: a positive

price effect whereby the price of the final consumption index decreases as

import competition intensifies, and an ambiguous wealth effect due to the

change in the value of households’ portfolios. The model predicts that if the

price of risk is negative, the risk premium should be concentrated among small

and less productive firms, and among these firms, in industries with strong

business-stealing effects. We find that all of these predictions hold in the cross-

section of expected returns.

We calibrate the model using standard parameter values and analyze im-

pulse responses of cash flows, valuations, and consumption to positive foreign

productivity shocks. If perfect risk-sharing is allowed across countries, then

households are diversified internationally and consumption always increases

following foreign productivity shocks. The risk premium of firms in low SC

industries is close to zero and the sign of the price of risk is positive, contrary

to our empirical finding that it is negative. Hence, a standard model of trade

with asset prices and perfect risk-sharing fails to rationalize the globalization

risk premium.