Abstract
The effect of COVID-19 on stock market performance has important implications for both financial theory and practice. This paper examines the relationship between COVID-19 and the instability of both stock return predictability and price volatility in the U.S over the period January 1st, 2019 to June 30th, 2020 by using the methodologies of Bai and Perron (Econometrica 66:47–78, 1998. https://doi.org/10.2307/2998540; J Appl Econo 18:1–22, 2003. https://doi.org/10.1002/jae.659), Elliot and Muller (Optimal testing general breaking processes in linear time series models. University of California at San Diego Economic Working Paper, 2004), and Xu (J Econ 173:126–142, 2013. https://doi.org/10.1016/j.jeconom.2012.11.001). The results highlight a single break in return predictability and price volatility of both S&P 500 and DJIA. The timing of the break is consistent with the COVID-19 outbreak, or more specifically the stock selling-offs by the U.S. senate committee members before COVID-19 crashed the market. Furthermore, return predictability and price volatility significantly increased following the derived break. The findings suggest that the pandemic crisis was associated with market inefficiency, creating profitable opportunities for traders and speculators. Furthermore, it also induced income and wealth inequality between market participants with plenty of liquidity at hand and those short of funds.
Highlights
The novel coronavirus 2019 (COVID-19) disease has led to an unprecedented disruption to the U.S economy and an unparalleled slump in the U.S stock market
Using daily data from January 1st, 2019 to June 30th, 2020 and the structural break tests proposed by Bai and Perron (1998, 2003), Elliot and Mullier (2004) and Xu (2013), we find that there exists a single break for both Standard and Poor’s 500 (S&P 500) and Dow Jones Indus‐ trial Average (DJIA) return prediction models
We find that stock return predictability was subject to a structural break which can be ascribed to COVID-19 during the period under investigation
Summary
The novel coronavirus 2019 (COVID-19) disease has led to an unprecedented disruption to the U.S economy and an unparalleled slump in the U.S stock market. The arrived consensus is that stock prices severely dropped and price fluctuation greatly enlarged following the occurrence of the pandemic disease Those studies did not test whether and when COVID-19 triggered the dramatic changes in stock market performance assuming no prior knowledge of the break location. They only focused on price changes and volatility but failed to concern return predictability which is an important theme in the finance literature. This paper tests for structural breaks in return predictive and price volatility models without COVID-19 variables and investigates the linkage between those breaks and COVID-19, providing explicit empirical evidence about whether and how public crisis affects market performance. We conclude the paper with suggestions to both investors and policy makers
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