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Detecting Illegal Arms Trade

by Stefano DellaVigna and Eliana La Ferrara. Reading for Tuesday, 2 October.

Illegal arms around the world are likely responsible for thousands of deaths every year, yet their trade is very hard to detect. We propose a method to detect illegal arms trade based on the investor knowledge embedded in financial markets. We focus on eight countries under UN arms embargo in the period 1990-2004. We consider events during the embargo that suddenly increase or decrease conflict intensity, and examine the contemporaneous stock returns of weapon-making companies. If the companies are not trading or trading legally, an event worsening the hostilities will not affect stock prices or affect them adversely, since it delays the removal of the embargo. Conversely, if the companies are trading illegally, the event may increase stock prices, since it increases the demand for illegal weapons. In aggregate analysis over the whole sample we find no significant stock response to the events but we detect a large and significant positive reaction for companies trading in non-OECD markets. When we rely on event studies at the company level, we find a total of 12 companies from both OECD and non-OECD markets that display a pattern of reactions consistent with illegal trade. Our analysis suggests that investors believe some companies are selling arms that will ultimately reach countries under embargo.

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