From Local to Global: Offshoring and Asset Prices

Social Sciences Research Network

2018

Industries differ in the extent to which they can offshore their production. I document that industries with low offshoring potential have 7.31% higher stock returns per year compared to industries with high offshoring potential, suggesting that the possibility to offshore affects industry risk. This risk premium is concentrated in manufacturing industries that are exposed to foreign import competition. Put differently, offshoring effectively serves as an insurance against import competition. A two-country general equilibrium dynamic trade model in which firms have the possibility to offshore rationalizes the return patterns uncovered in the data: Industries with low offshoring potential carry a risk premium which is increasing in foreign import penetration. Within the model, the offshoring channel is economically important and lowers industry risk up to one-third. I find that an increase in trade barriers is associated with a drop in asset prices of model firms. The model thus suggests that the loss in benefits from offshoring outweighs the benefits from lower import competition. Importantly, the model prediction that offshorability is negatively correlated with profit volatility is supported by the data.

Asset Prices; Import Competition; Offshoring

Social Sciences Research Network

No

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