Working Paper: NBER ID: w27784
Authors: Josue Cox; Daniel L. Greenwald; Sydney C. Ludvigson
Abstract: What explains stock market behavior in the early weeks of the coronavirus pandemic? Estimates from a dynamic asset pricing model point to wild fluctuations in the pricing of stock market risk, driven by shifts in risk aversion or sentiment. We find further evidence that the Federal Reserve played a role in these fluctuations, via a series of announcements outlining unprecedented steps to provide several trillion dollars in loans to support the economy. As of July 31 of 2020, however, only a tiny fraction of the credit that the central bank announced it stood ready to provide in early April had been extended, reinforcing the conclusion that market movements during COVID-19 have been more reflective of sentiment than substance.
Keywords: COVID-19; Stock Market; Federal Reserve; Risk Aversion; Sentiment
JEL Codes: G12; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Pricing of stock market risk (G19) | S&P 500 index decline (G12) |
| Investor sentiment (G41) | Pricing of stock market risk (G19) |
| Risk aversion (D81) | Pricing of stock market risk (G19) |
| Federal Reserve actions (E52) | S&P 500 index increase (C43) |
| Federal Reserve actions (E52) | Russell 2000 index increase (C43) |
| Market sentiments (G10) | S&P 500 index decline (G12) |
| Federal Reserve communications (E52) | Market sentiments (G10) |