How has COVID-19 affected stock markets?

Responsible researcher: Viviane Pires Ribeiro

Paper Title: How Do Equity Markets React to COVID-19? Evidence from Emerging and Developed Countries

Authors: Maretno Agus Harjoto, Fabrizio Rossi, Robert Lee, Bruno S. Sergi

Location of Intervention: Emerging countries and developed countries

Sample Size: 76 countries

Big topic: Finance

Variable of Main Interest: Number of cases and deaths from COVID-19

Type of Intervention : Impact of COVID-19 on stock markets

Methodology: Multivariate regressions

The world is experiencing an unprecedented shock due to the novel coronavirus outbreak, also known as COVID-19. In this uncertain environment, several studies have examined the impact of COVID-19 on stock market returns and volatility. Thus, the study carried out by Harjoto et al. (2021) extends this existing literature by empirically examining the impact of COVID-19 on stock markets during the period January to August 2020. The results obtained highlight that the unprecedented adverse shock of COVID-19 on the economic growth of countries translates into a negative shock for stock markets.

Assessment Context

The spread of COVID-19, measured by the number of cases and deaths, brought an unprecedented adverse shock to stock markets. Initially found in December 2019 in the city of Wuhan, China, COVID-19 has spread to 216 countries and territories. Unlike other previous pandemic diseases such as Bird Flu, Severe Acute Respiratory Syndrome (SARS), Swine Flu, Ebola and Middle East Respiratory Syndrome (MERS) that significantly increased volatility in the stock market, COVID-19 presented the strongest impact in the history of these markets.

The World Health Organization (WHO), government agencies and the media publish daily the number of new cases and deaths from COVID-19, which highlights the speed of transmission (cases) and the mortality rate (deaths) due to this pandemic during periods of rising (pre-April) and stabilization (post-April) infection. However, despite several studies examining the impact of COVID-19 on economic growth and stock markets, no studies have been identified in the literature that have analyzed how stock market indices across the world react to daily cases and to mortality rates during these two periods of COVID-19 spread. Furthermore, it is noted that although previous studies have examined the impact of COVID-19 on emerging countries, none of these compare the impact of COVID-19 on the stock markets of emerging countries with the impact of COVID-19 on stock markets of developed countries.

Intervention Details

Given that the World Health Organization, government agencies, and the media continue to provide daily numbers of COVID-19 cases and deaths, the study by Harjoto et al. (2021) contributes to the literature by exploring whether and how stock market returns, volatility, and trading volume were affected by the percentages of daily COVID-19 cases and deaths. The study also extends current literature that focuses mainly on developed countries or emerging countries by conducting a direct comparison of the impact of the pandemic on 53 emerging countries and 23 developed countries.

To carry out this analysis, data was compiled based on the daily numbers of new cases, cumulative cases and deaths that are available on the World Health Organization Situation Report website from January 14, 2020 to August 20, 2020. After searching the web for different countries, the authors observed that 78 of the 216 countries and territories have stock indices. Daily data from the main stock indices of 77 countries were downloaded from the Bloomberg terminal. Iran's stock market index was retrieved from the Tehran Stock Exchange website. Two countries (i.e. Bangladesh and Kuwait) did not have information on stock indices, trading volume or volatility and were excluded from the sample.

The authors merged WHO data with stock index data based on country names and dates. After excluding missing observations, the final sample consisted of 8,985 observations from 76 countries. The sample was also divided into 5,940 observations from 53 emerging countries and 3,045 observations from 23 developed markets based on the Morgan Stanley Capital International (MSCI) market classification.

Therefore, the authors considered two subsample periods: the period of increasing COVID-19 infection, between January 14 and March 31, 2020 (before April), where infection rates increased rapidly; and the infection stabilization period, covering the period from April 1 to August 20, 2020 (post-April), where infection rates begin to decline and become more stable.

Methodology Details

To account for variations in COVID-19 cases and deaths in different countries, Harjoto et al. (2021) calculated the percentage of daily increase (percentage of new cases) as the daily new cases divided by the cumulative cases to measure the speed of transmission. The daily death rate (percentage of new deaths) was calculated as daily new deaths divided by cumulative cases. The percentage of daily stock index returns (RET) for each country were also calculated. Following the combination of distribution hypothesis, the authors used daily trading volume (TVOLUME) and 30-day volatility (VOLAT) as the two measures of volatility in stock markets. Finally, the natural log of the daily trading volume (natural log of TVOLUME or VOLUM) was used to reduce the asymmetry of the daily trading volume.

Multivariate regressions were used to examine the impact of the daily percentage increase in the number of cases and deaths due to COVID-19 on the daily return (RET), volatility (VOLAT), and the natural logarithm of trading volume (VOLUM). The one-day lag of RET, VOLAT, and VOLUM was included to control for autocorrelation and mean-reverting characteristics of stock returns, volatility, and trading volume. The authors included monthly dummy variables (with August as the excluded dummy) and 75 country dummy variables (with United States as the excluded dummy) in order to control for differences in stock market characteristics across different months and countries.

Results

The results obtained show that global stock markets in 76 countries reacted negatively to COVID-19 spreads, measured by the percentage of new daily cases and the death rate. The results show that investors withdrew their investments in stocks when they witnessed increasing transmission (emergence of new cases) and an increase in the number of deaths from COVID-19, which resulted in lower returns, greater volatility and higher trading volume.

That is, strong evidence was found that an increase in daily cases and death rates adversely affects the daily returns of stock markets. Daily cases and death rate increase daily volatility and daily trading volume. The results suggest that these impacts are statistically and economically significant. They also suggest that daily cases and death rates affect daily returns, volatility and trading volume in emerging countries. In contrast, only daily cases affect daily return, volatility and trading volume in developed countries. Analysis indicates that COVID-19 cases and death rates significantly affect daily stock returns, volatility, and trading volume during the period with increasing infection rate. Cases and death rates only affect volatility during the infection stabilization period. This latest finding supports the overreaction hypothesis and indicates that stock markets appear to overreact during the period of rising infection.

Public Policy Lessons

Harjoto et al. (2021) argue that company productivity determines stock market returns. As countries around the world instituted lockdowns and stay-at-home orders, the COVID-19 outbreak brought significant global disruptions to economic activities such as supply chains, productions and consumptions. Investors translated these disruptions in economic activities by immediately withdrawing their investments from stock markets, which generated negative returns, greater volatility and higher trading volume. Based on institutional theory, Harjoto et al. (2021) hypothesize that the impact of COVID-19 on emerging markets is different from the impacts on developed markets. The research found different investment behaviors between emerging and developed markets, such as risk and return structure, so the authors believe that the impact of COVID-19 will be different between these two markets.

The study extends recent literature hypothesizing market overreaction to COVID-19 by demonstrating that there is a temporary effect of COVID-19 cases and death rates on stock markets during the period of rising infections (before April) and the stabilization period (post-April). It turned out that market reactions are lower during the stabilization period. This finding supports evidence that investors can discern relevant information about the real impacts of COVID-19 and the ramifications of lockdowns on the economy and companies' business activities. Additionally, the study provides insight into how emerging and developed markets might react if a second or third wave of COVID-19 appears or if vaccines are proven useful in containing the spread of the virus.

References

Harjoto, M.A., Rossi, F., Lee, R., & Sergi, B.S. (2021). How do equity markets react to COVID-19? Evidence from emerging and developed countries. Journal of Economics and Business , 115 , 105966.