Principal investigator: 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 the Intervention: Emerging countries and developed countries
Sample Size: 76 countries
Main theme: Finances
Main Variable of Interest: Number of COVID-19 cases and deaths
Type of InterventionImpact 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 environment of uncertainty, several studies have examined the impact of COVID-19 on stock market returns and volatility. Thus, the study conducted by Harjoto et al. (2021) extends this existing literature, empirically examining the impact of COVID-19 on stock markets during the period from January to August 2020. The results obtained show that the unprecedented adverse shock of COVID-19 on countries' economic growth translates into a negative shock for stock markets.
Evaluation Context
The spread of COVID-19, measured by the number of cases and deaths, has 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 Avian Influenza, Severe Acute Respiratory Syndrome (SARS), Swine Flu, Ebola, and Middle East Respiratory Syndrome (MERS), which significantly increased stock market volatility, COVID-19 has had the strongest impact in the history of these markets.
The World Health Organization (WHO), government agencies, and the media publish daily figures on the number of new COVID-19 cases and deaths, highlighting the speed of transmission (cases) and the mortality rate (deaths) of this pandemic during periods of increasing infection (before April) and stabilization (post-April). However, despite several studies examining the impact of COVID-19 on economic growth and stock markets, no study has been identified in the literature that has analyzed how stock market indices worldwide react to daily cases and mortality rates during these two periods of COVID-19 spread. Furthermore, it is observed that while previous studies have examined the impact of COVID-19 on emerging countries, none compare the impact of COVID-19 on emerging market stock markets with the impact of COVID-19 on developed market stock markets.
Intervention Details
Given that the World Health Organization, government agencies, and the media continue to provide daily figures on COVID-19 cases and deaths, the study conducted 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 the current literature that focuses primarily on developed or emerging countries by conducting a direct comparison of the pandemic's impact in 53 emerging countries and 23 developed countries.
To conduct this analysis, data was compiled from daily figures for new cases, cumulative cases, and deaths available on the World Health Organization Situation Report website from January 14, 2020, to August 20, 2020. After web searches for different countries, the authors observed that 78 of the 216 countries and territories have stock indices. Daily data for the major stock indices of 77 countries were downloaded from the Bloomberg terminal. The Iranian stock market index was retrieved from the Tehran Stock Exchange website. Two countries (namely, Bangladesh and Kuwait) lacked 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.
Thus, 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 period of infection stabilization, covering the period from April 1 to August 20, 2020 (post-April), where infection rates begin to decrease 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 daily percentage increase (percentage of new cases) as the number of new daily cases divided by the cumulative number of cases to measure the speed of transmission. The daily mortality rate (percentage of new deaths) was calculated as the number of new daily deaths divided by the cumulative number of cases. The percentage of daily stock index returns (RET) was also calculated for each country. Following the combined distribution hypothesis, the authors used daily trading volume (TVOLUME) and 30-day volatility (VOLAT) as the two measures of volatility in the stock markets. Finally, the natural logarithm of daily trading volume (natural logarithm of TVOLUME or VOLUME) was used to reduce the asymmetry of daily trading volume.
Multivariate regressions were used to examine the impact of the daily percentage increase in the number of COVID-19 cases and deaths on daily return (RET), volatility (VOLAT), and the natural logarithm of trading volume (VOLUM). A one-day lag of RET, VOLAT, and VOLUM was included to control for autocorrelation and mean-reversion 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 the United States as the excluded dummy) in order to control for differences in stock market characteristics across different months and countries.
Results
The results show that global stock markets in 76 countries reacted negatively to COVID-19 spreads, measured by the percentage of new daily cases and the mortality rate. The results indicate that investors withdrew their stock investments when they witnessed increasing transmission (the emergence of new cases) and a rise in the number of COVID-19 deaths, resulting in lower returns, higher volatility, and higher trading volume.
That is, strong evidence was found that an increase in daily cases and mortality rates adversely affects the daily return of stock markets. Daily cases and mortality rates 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 mortality rates affect daily return, volatility, and trading volume in emerging countries. In contrast, only daily cases affect daily return, volatility, and trading volume in developed countries. The analysis indicates that COVID-19 cases and mortality rates significantly affect daily stock returns, volatility, and trading volume during the period with an increasing infection rate. Cases and mortality rates only affect volatility during the period of infection stabilization. This last finding supports the overreaction hypothesis and indicates that stock markets appear to have an overreaction during the period of increasing infection.
Lessons in Public Policy
Harjoto et al. (2021) argue that firm 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, production, and consumption. Investors translated these disruptions in economic activity 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 differs from its impact on developed markets. Research has found different investment behaviors between emerging and developed markets, such as risk-return structure; thus, the authors believe that the impact of COVID-19 will be different between these two markets.
This study extends recent literature presenting the hypothesis of market overreaction to COVID-19, demonstrating that there is a temporary effect of COVID-19 cases and mortality rates on stock markets during the period of increased infections (before April) and the period of stabilization (post-April). Market reactions were found to be smaller during the stabilization period. This finding supports the evidence that investors can discern relevant information about the real impacts of COVID-19 and the ramifications of lockdowns on the economy and business activities. Furthermore, 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 prove effective 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.
