The Impact of 2007-2008 Financial Crisis on Stock Return in China and the U.S - Assignment Example

PROPOSED TITLE: ‘The Impact of 2007-2008 Financial Crisis on Stock Return in China and the U.S.’

AT LEAST FIVE REASONS WHY YOUR RESEARCH IS IMPORTANT:

1. The proposed study will provide information on the financial downfall that was evident in the global stock market as result of the crisis of 2007-2008. The financial crisis was a massive setback to the operations of the global stock market, the negative effects of which is still evident within the economic conditions of the developing countries all round the world (Shah, 2013). Therefore, the study will elaborate on a crucial occurrence of the modern economic system, emphasizing its major limitations that can be resolved to prevent similar turmoil in future.

2. The reasons behind the occurrence of the crisis and most importantly the impact that this crisis had on the financial conditions of the developing nations will be critically assessed in the proposed study. It is often argued that the most significant reason for this global financial crisis was the sudden collapse of the world’s most widely operating bank, the Lehman Brothers in the month of September, 2008 (The Economist Newspaper Limited, 2013). However, it has been a matter of debate as to whether the collapse of Lehman Brothers can be denoted as a reason of the financial crisis or an indication to the gaps in the modern economic setting.

3. The proposed study will narrow down its evaluation of the effects of the crisis on the stock returns of particularly two nations, the US and China, as both the markets are noted to have depicted substantial differences in their reactions to the turmoil. For instance, the mortgage facility (housing market bubble) that had been made functional in America was an act of great irresponsibility, which in turn led the nation towards immense level of downturn in terms of the prices of houses and properties (The Economist Newspaper Limited, 2013; Crotty, 2009). Similarly, the investors of China were also held responsible because they provided people with higher returns on the securitized products even in the areas where the interest rates were relatively the lowest (The Economist Newspaper Limited, 2013; Obstfeld & Rogoff, 2009). Hence, the debate is apparent in this context that will be addressed in the study.

4. The proposed study will also provide an in-depth understanding regarding the impacts of the financial crisis on the stock markets in various other countries, such as the United Arab Emirates (UAE), Egypt, Kuwait, Jordan, and Morocco as a result of the global financial crisis. The global financial crisis certainly had a long term impact on these nations, while some were able to recover sooner than others and face only negligible influence of the turmoil (Neaime, 2012). The proposed study, focused on the performances of these economies during and after the global financial crisis will contribute to the better understanding of the global economic system and its limitations that led to the issue.

5. Although many researches have been conducted with significance to the impacts of the global financial crisis, only limited studied concentrated on the stock market situations of the nations. Moreover, lacuna of precision and comprehensibility of those studies have also contributed to a literature gap concerning the issue identified. The proposed study will therefore be beneficial in bridging the gap related to the stated issue.

AT LEAST FIVE RESEARCH QUESTIONS YOU WILL ANSWER:

1. What factors affected stock market returns during the global financial crisis in the year 2007-2008 in the US and China?

2. How did the stock returns compare (similarities and differences) in the selected US and Chinese companies during the global financial crisis?

3. What were the causes behind the similarities and the differences observed in stock market fluctuations for the US and Chinese companies during the global financial crisis?

4. Which factors helped in the recovery process of the US and Chinese companies to overcome the shock of the global financial crisis in the year 2007-2008?

5. Which factors can help to prevent future severe impacts of global financial crisis on stock returns?

AT LEAST FIVE HYPOTHESES THAT YOU WILL TEST:

1. Earning base of the US based companies suffered significant downfall during the global financial crisis in the year 2007-2008, resulting in a decline of its stock returns.

The banks as well as the mortgage institutions earned in bulks from the securitization of mortgages along with distributing them to capital markets as collateralized debt obligations (CDOs) as well as mortgage backed securities (MBSs) (Crotty, 2009). The nation had to face massive and continuous deficits in current accounts as a result of the economic breakdown, but later on was largely financed by its periphery. The dropping of the stock market rates of the US for a longer span of time would in turn lead the global economy towards a phase of extreme recession (Caballero, 2009).

2. Earning base of the Chinese companies suffered significant downfall during the global financial crisis in the year 2007-2008, resulting in a decline of its stock returns.

The financial crisis of 2007-2008 had struck the entire world so immensely that not only the stock market of the developed countries such as the US was seen falling, but the effect was also evident in developing countries such as China, which especially affected the Chinese export market largely (Cali et.al., 2008). At that point of time, the governments of the most developed and the wealthiest countries of the world had come to their rescue with innumerable packages, thereby helping to stabilize their financial condition considerably (Shah, 2013).

3. Discount rate fluctuations of the US based companies suffered significant downfall during the global financial crisis in the year 2007-2008, resulting in a decline of its stock returns.

The volatility of the stock market is a serious matter of concern for the global financial market, which had been largely hampered as a result of the global financial crisis. This will therefore represent the risk that the global economy had to undergo. The adverse effects of the financial turmoil during the years 2007 and 2008 were mostly borne by the high-risk taking investors which had also hampered the development of the nations to a large extent. (Karunanayake et.al., 2010).

4. Discount rate fluctuations of the Chinese companies suffered significant downfall during the global financial crisis in the year 2007-2008, resulting in a decline of its stock returns.

The fluctuation in the interest rate, as well as the risks related to the same in case of the financial sectors will be effectively presented in the findings with the respect to the issue of concern (Mouna & Anis, 2016).

5. Stock return fluctuations had parity in terms of both US and Chinese companies the global financial crisis in the year 2007-2008.

The effect of the global economy, especially the US on the stock market of China is an issue of major concern as far as the global economy is concerned. This is so because China acts a major contributor to the global GDP (Li et.al., 2012). Moreover, the distortions in the complementary policies of China as a result of maintaining a lower interest rate on investments therein had also increased the adverse affects of the crisis, thereby making it even more troublesome for it to mitigate the future course of actions (Obstfeld & Rogoff, 2009).

DATA SOURCES:

1. DataStream along with Reports published through OECD, World Bank, IMF and others

2. Journals, articles and other scholarly data sources

3. NYSE, SEHK and SSE

HOW WOULD YOU BE PRESENTING SUMMARY STATISTICS ON YOUR SAMPLE?

SAMPLE SIZE: 100 companies (5 companies from 10 industries of both China and the US)

SAMPLE COMPANIES:

50 selected companies of the US and China registered under NYSE, SEHK and SSE stock markets. The companies have been selected using the simple random sampling order to eliminate biasness to the utmost level possible.

LISTS OF VARIABLES YOU WILL BE COLLECTING: i (nominal fed funds rate), r* (real federal funds rate (usually 2%) during the period), pi (rate of inflation during the period), p* (target inflation rate of the time), Y (logarithm of real output) and y* (logarithm of potential output), re (current value per share in the period), Dt (dividends paid out in the period), g (the dividend growth rate per year in the period), Pt (share price in the period), Rft (risk-free rate in the period), βt (the fluctuation rate of the share price in the period), (Rm-Rf)t (equity market risk premium in the period), P0 (initial stock price at the beginning of the 2007-08 crisis), P1 (stock price recorded after the ending of the 2007-08 crisis) and D (the dividends held by companies during the period)

METHODS YOU PROPOSE TO USE:

UNIVARIATE ANALYSIS:

• Test of means in single sample: z-test, F-test, Wald test
• Test of median between samples: Kruskal-Wallis test, ANOVA, Mann-Whitney U test
• Correlation Matrix will consist of which variables:

i (nominal fed funds rate), r* (real federal funds rate (usually 2%) during the period), pi (rate of inflation during the period), p* (target inflation rate of the time), Y (logarithm of real output) and y* (logarithm of potential output), re (current value per share in the period), Dt (dividends paid out in the period), g (the dividend growth rate per year in the period), Pt (share price in the period), Rft (risk-free rate in the period), βt (the fluctuation rate of the share price in the period), (Rm-Rf)t (equity market risk premium in the period), P0 (initial stock price at the beginning of the 2007-08 crisis), P1 (stock price recorded after the ending of the 2007-08 crisis) and D (the dividends held by companies during the period)

MULTIVARIATE ANALYSIS:

Coffmp = α0 + β1r* + β2pi + β3[0.5 (pi-pi*)] + β4[0.5 (Y-y*)] + е

Eb = α0 + β1[Dt(1 + g)]/Pt + β2g + е

Re = α0 + β1Rft + βt(Rm-Rf)t + e

r = α0 + β1[(P1 – P0) + D] + β2P0 + e

Here, α0 = Constant; e = Error term, β1, β2, β3, β4 and βt are the coefficients to the independent variables

Notes:

• Co-efficient of monetary policy (Coffmp) will be calculated using the Taylor rule, where i = r* + pi + 0.5 (pi-pi*) + 0.5 (Y-y*). Here, i implies nominal fed funds rate, r* implies real federal funds rate (usually 2%) during the preiod, pi implies rate of inflation during the period, p* implies target inflation rate of the time, Y implies logarithm of real output and y* implies logarithm of potential output (Hofmann & Bogdanova, 2012).
• Earning base (Eb) will be calculated using the formula ret = [Dt(1 + g)]/Pt + g, where re implies the current value per share in the period (t), Dt implies dividends paid out in the period (t), g implies the dividend growth rate per year in the period (t) and Pt implies share price in the period (t) (ACCA, 2012).
• Cost of equity (Re) will be calculated using the formula (Re)t = Rft + βt (Rm-Rf)t, where Rft implies the risk-free rate in the period (t), βt implies the fluctuation rate of the share price in the period (t), (Rm-Rf)t implies the equity market risk premium in the period (t) (Bragg, 2011).
• Stock returns (r) will be calculated using the formula r = (P1 – P0) + D] / P0, where P0 refers to the initial stock price at the beginning of the 2007-08 crisis, P1 implies stock price recorded after the ending of the 2007-08 crisis and D implies the dividends held by companies during the period. The exact duration of the financial crisis is still debated among the experts and thus, to avoid confusions, the period to be considered for this study from range from December 2007 (starting) to December 2011 (ending).

EXPECTED FINDINGS:

With regards to Hypothesis 1: The obtained findings will show that during financial crisis, the earning base of the US based companies had declined, causing fluctuations in stock returns for the companies.

With regards to Hypothesis 2: The obtained findings will show that during financial crisis, the earning base of the Chinese companies had declined, causing fluctuations in stock returns for the companies.

With regards to Hypothesis 3: The obtained findings will show that during financial crisis, discount rate fluctuations of the US companies had declined, causing fluctuations in stock returns for the companies.

With regards to Hypothesis 4: The obtained findings will show that during financial crisis, discount rate fluctuations of the Chinese companies had declined, causing fluctuations in stock returns for the companies.

With regards to Hypothesis 5: The obtained findings will show if both the US and the Chinese stock markets were affected similarly during the financial crisis.

Reference List:

• ACCA, 2012. Business valuations. Global. [Online] Available at: http://www.accaglobal.com/content/dam/acca/global/PDF-students/2012s/sa_feb12_f9_valuationsv2.pdf [Accessed June 25, 2016].
• Bragg, S. M., 2011. The New CFO Financial Leadership Manual. John Wiley & Sons.
• Caballero, R.J., 2009. Global Imbalances and the Financial Crisis: Products of Common Causes. Federal Reserve Bank of San Francisco Global Recovery: Asia and the New Financial Landscape Conference Proceedings, pp. 173-177.
• Cali, M. et.al., 2008. The Global Financial Crisis: Financial Flows To Developing Countries Set To Fall By One Quarter. Overseas Development Institute, pp. 1-25.
• Crotty, J., 2009. Structural Causes of the Global Financial Crisis: A Critical Assessment of the ‘New Financial Architecture’. Cambridge Journal of Economics, Vol. 33, No. 4, pp. 563-580.
• Hofmann, B. & Bogdanova, B., 2012. Taylor Rules and Monetary Policy: A Global'Great Deviation'?. BIS Quarterly Review September.
• Karunanayake, I. et.al., 2010. The Effects of Financial Crises on International Stock Market Volatility Transmission. University of Wollongong, pp. 1-25.
• Li, L. et.al., 2012. The Effects of the Global Financial Crisis on China's Financial Market and Macroeconomy. Economics Research International, pp. 1-6.
• Mouna, A. & Anis, J., 2016. Market, Interest Rate, and Exchange Rate Risk Effects on Financial Stock Returns during the Financial Crisis: AGARCH-M Approach. Cogent Economics & Finance, Vol. 4, No. 1, pp. 1-16.
• Neaime, S., 2012. The Global Financial Crisis, Financial Linkages and Correlations in Returns and Volatilities in Emerging MENA Stock Markets. Emerging Markets Review, Vol. 13, No. 3, pp. 268-282.
• Obstfeld, M. & Rogoff, K., 2009. Global Imbalances and the Financial Crisis: Products of Common Causes. Paris School of Economics, pp. 1-69.
• Posen, A. S. & Changyong, R., 2013. Responding to Financial Crisis: Lessions from Asia Then, the United States and Europe Now. Peterson Institute for International Economics.
• Shah, A. 2013. Global Financial Crisis. Article. [Online] Available at: http://www.globalissues.org/article/768/global-financial-crisis [Accessed June 25, 2016].
• The Economist Newspaper Limited, 2013. The Origins of the Financial Crisis: Crash Course. News. [Online] Available at: http://www.economist.com/news/schoolsbrief/21584534-effects-financial-crisis-are-still-being-felt-five-years-article [Accessed June 25, 2016].