Market anticipations of conflict onsets
| Author | Thomas Chadefaux |
| Published date | 01 March 2017 |
| DOI | 10.1177/0022343316687615 |
| Date | 01 March 2017 |
| Subject Matter | Research Articles |
Market anticipations of conflict onsets
Thomas Chadefaux
Department of Political Science, Trinity College Dublin
Abstract
Does the recurrence of wars suggest that we fail to recognize dangerous situations for what they are, and are doomed
to repeat the errors of the past? Or rather that policymakers correctly anticipate the consequences of their actions but
knowingly choose conflict? Unfortunately, little is known about how well wars are anticipated. Do conflicts tend to
come as a surprise? I estimated the risk of war as perceived by contemporaries of all interstate and intrastate conflicts
between 1816 and 2007. Using historical financial data of government bond yields, I find that market participants
tend to underestimate the risk of war prior to its onset, and to react with surprise immediately thereafter. This result
illustrates how conflict forecasts can be self-fulfilling or self-defeating. Present predictions may affect future behavior,
such that wars may be less likely to occur when they are predicted, but more likely when they are not. I also show that
the forecasting record has not improved over the past 200 years, and that wars involving democracies lead to greater
market shocks. These findings also have implications for the way decisionmakers respond to new information, and
how audiences perceive the risk of war and hence their leaders’ actions.
Keywords
conflict, financial markets, forecasting, government bonds, war
The recurrence of wars, despite their tremendous eco-
nomic, social, and institutional costs, may suggest that
we are doomed to repeat the errors of the past. Time after
time, policymakers seem to mispredict the consequences
of their actions and fail to recognize dangerous situations
for what they are. Can the risks of war be correctly
estimated, or do we really only learn from history that
we do not learn from it?
Unfortunately, little is known about how well wars
are anticipated. Do conflicts indeed tend to come as a
surprise to their contemporaries? Or are they correctly
anticipated, but decisionmakers choose to engage in
them anyway? Using financial data, I examine the reac-
tion of market participants to the onset of all civil and
interstate conflicts from 1816 to 2007. If wars are cor-
rectly predicted, then those who have a stake in them
should not be surprised by their onset. Yet, we find the
opposite: investors have historically underestimated the
probability of war prior to its outbreak and the onset
typically led to a large correction. Market participants,
in particular, could often have obtained better returns
had they correctly estimated the risk of war.
Whether observers correctly estimate the risk of war
matters for several reasons. First, understanding how past
observers have fared is a first step in identifying possible
ways to improve future forecasts. Second, are there types
of war or attributes of the warring countries that increase
the predictability of conflict? And are forecasts improv-
ing? Third, the findings are relevant to the large literature
on the public’s reaction to their leaders’ foreign policy
choices. One important assumption in that literature is
that the leaders’ choices are clearly and unambiguously
understood by those who decide their fate. Audiences
may, for example, punish leaders for reckless actions that
escalate the risk of war. Yet, if observers misestimate the
risks of war, then there are important implications for
our understanding of audience costs and costly signals,
for example. Can leaders really tie their hands or more
generally signal their intentions if the associated risk of
war is misestimated?
Corresponding author:
thomas.chadefaux@tcd.ie
Journal of Peace Research
2017, Vol. 54(2) 313–327
ªThe Author(s) 2017
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DOI: 10.1177/0022343316687615
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