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Global financial markets are affected by the rapid spread of COVID-19 (coronavirus). Investors have suffered significant losses quickly due to the unprecedented risk created by this virus. This paper aims to map the general systemic and country-specific risk patterns in global financial markets. The report also analyzes the possible consequences of policy interventions such as the US decision to implement zero percent interest rates and unlimited quantitative ease (QE) and to what degree these policies could introduce additional uncertainties to global financial markets.
Keywords: Coronavirus Financial markets, Pandemic Quantitative, ease Systemic Risk
The following is a brief introduction to the topic:
The World Health Organization (WHO), on 11 March 2020, declared the COVID-19 outbreak a global pandemic 1. The number of confirmed cases has surpassed 500,000 since 27 March 2020 and continues to increase ( WHO, 2020). More than 170 countries have been affected. The US has the highest number of confirmed cases. The economic impact of the outbreak is evident. As many countries have adopted strict quarantine policies in the short term, their economic activity is significantly restricted. Long-term, this pandemic could lead to mass unemployment and the failure of businesses. Tourism and aviation will undoubtedly be affected.
Financial markets have already reacted with dramatic movements, even though the exact economic impact on the world is unknown. The US stock market triggered the circuit-breaker mechanism four times in ten days. The circuit breaker mechanism has been activated only once since its creation in 1987. That was in 1997. Stock markets in Europe, Asia, and the US have all fallen along with them. The stock market in Japan fell more than 20% since its peak in December 2019. 1 Central banks and governments responded by launching their policy instruments on the market. On 15 March 2020, for example, the Federal Reserve announced a zero percent interest rate policy and at least $700 billion in quantitative easing. Eight days after the FED’s initial announcement, it announced a no-limited QE program. While most stock markets are beginning to recover, there is still much uncertainty as the pandemic continues.
This paper examines available data to describe the situation firsthand and better understand patterns of systemic risks in financial markets. It also attempts to answer questions such as: How do stock market risks react to a pandemic disease outbreak? Are systemic risks increasing globally? What are the possible impacts of policy interventions on global risks?
This paper continues as follows. Section 2. describes the basics of the pandemic. Section 3. Presents the statistical analysis. Section 4. discusses policy impacts. Section 5. Concludes.
Pandemic facts and figures
COVID-19 came to the attention of the world in January 2020. The rapid spread and increasing number of confirmed cases prompted quick responses from the Chinese Government. The lockdown of Wuhan on 23 January 2020 shocked the world. It was later proven to be an effective policy by the Chinese Government. One week after the WHO’s declaration, the WHO classified the outbreak as a PHEIC (public health emergency of international concerns). The WHO declared the outbreak in China a public health emergency of global concern (PHEIC) one week later.
South Korea, followed closely by Iran, was the country that experienced a major COVID-19 outbreak. South Korea went from 31 to over 1,000 cases in one week, and Iran from zero to more than 1,000 cases in 12 days. The confirmed cases for six of the most affected countries are plotted using data from the John Hopkins Coronavirus Resource Center (see Figure). 1 ). In March, while China and South Korea were generally under control, the epicenter moved to Europe. Italy has the highest death rate, despite the US having the most confirmed cases. Financial markets around the world began to fall after the WHO announced a pandemic. S&P 500, for example, reached its peak (3386.15) in February 2020 but plummeted to 2237.40 by 23 March 2020. This is a drop of more than 30% in just one month. In February, the standard deviation for daily returns was 0.0069. This number increases to 0.0268 by March.
In 2003, it was estimated that severe acute respiratory disease (SARS) would cost the global economy between 30 and 100 billion dollars ( Smith, 2006). The COVID-19 pandemic, which was first reported in China and has now spread worldwide, behaves as “the once-in-a-century pathogen” ( gates, 2020). The global economy will be affected more profoundly.
Daily data were collected until 27 March 2020 to explore patterns of stock market reaction. Downloaded from investing.com are the indexes of all stock exchanges around the world. John Hopkins Coronavirus Resource Center provides all the data about global coronavirus infection.
3.1. Analysis of volatility
First, we will illustrate the link between the stock market and COVID-19. The top 10 countries with confirmed cases (as per data as of 27 March 2020) were selected, along with Japan, Korea, and Singapore. Iran has been excluded from the list because stock market data is unavailable. These countries, which all have developed stock markets, have together 466,693 instances (see Tab 1). Standard deviations are used to calculate market risk. As the WHO declared PHEIC in China on 30 January 2020, only February and March will be considered in this analysis. China was at the center of the outbreak for most of February. China has successfully contained the virus since early March. However, confirmed cases in Europe and the US are rising.
Market volatility and confirmed cases
Note: The John Hopkins Coronavirus Resources Center selected and ranked these countries. They are the ten most infected nations based on confirmed cases, including Japan, South Korea, and Singapore. Iran was omitted because its stock exchange data is unavailable. The standard deviations for daily returns in February or March are Std_February. The country’s ranking is based on Std_February. Rank 02 represents the country ranking based on Std_March.
Table 1. shows that the pandemic significantly impacted the stock market. Risk levels in all countries have increased considerably, with an average risk level of 0.0071 from February to 0.0196 in March. Such dramatic movements are likely due to long-term expectations. (Gormsen & Koijen 2020) Instead, sentimental factors will play a significant role. Social media can quickly increase market sentiment in response to an outbreak, causing extreme price changes ( Widestock & Zhang, 2018).
It is unsurprising that China had the highest standard deviation in February and the lowest in March. The US market volatility increased most in March, with the standard deviation nearly four times greater than in February. The definitive deviation ranking for March roughly matches the number of confirmed cases (excluding China). The pandemic is causing a lot of risk and uncertainty in the global financial market.
3.2. Analysis of correlation
As a result of a global health crisis, we expect an increase in country-specific risk in the stock market and a rise in systemic risk. Correlations are used here to illustrate how the pandemic will affect the stock market. Fig. The weekly correlations between these 12 countries are plotted in Fig. These correlations are calculated using daily data for each week in February and March. There are eight observations.
In February, correlations are low but increase significantly as we enter March. The correlations are at their highest in the week that ends on 6 March 2020, when Europe and the US start to lose control. This causes the WHO to declare a pandemic over the weekend (1 March 2020). The correlation for the week ending 20 March 2020 is surprisingly low. Investors around the globe had different opinions about the US policy of zero percent interest rates, but that changed when the new QE unlimited was announced the following week. The long-term impact of US policies is unclear, even though there was a global market rebound the next week, leading to higher correlations.
Two heat maps are shown, one before and one after the WHO announcement. 3 ). The four Asian stock markets behave very differently. Before the announcement, only China was isolated from the rest of the world, but now the entire Asia group is moving further away from Europe-US. After the information, they become more interconnected (the darker shade of blue). After the announcement of the agreement, South Korea’s correlation with China and Singapore was high, but it was not before.
3.3. Minimum spanning tree
The systemic relationships among these countries are further investigated based on the correlation analysis. This is done using graph theory and the minimum spanning tree method (MST), which connects all graph nodes in the shortest possible time and without loops (see Mantegna & Stanley, 2000). C ( i, j ) is the correlation of two variables. You can calculate their distance as
Fig. Figure 4 shows the MST before and after the announcement of the pandemic. Before the announcement of the pandemic, the European stock markets were strongly interconnected, as seen on the left panel. France, Germany, and the Netherlands form the MST’s core, each linking to three nodes. The US stock market and China Mainland are isolated from the rest of the system. The international financial markets have not responded to the outbreak in China with any significant changes.
When viewed on the right panel after the announcement, the MST tells a very different story. The European group is still highly interconnected. As a result of the COVID-19 epidemic, the UK and Spain have replaced Germany and the Netherlands as the core members. Germany is still positively affected, but its death rate is much lower than all other countries. After the announcement, four Asian stock exchanges that were scattered formed a cluster. These four Asian stock markets have a more integrated feel, even though a local core has not yet emerged.
Overall, the evidence here shows that regional market integration/collaboration will likely appear in the face of this major crisis. Before or after the global crisis, US stock markets have failed to play a significant role in the world.
Discussions on policy
Walter et al. According to (2020), the coronavirus will infect up to 7.0 billion people worldwide and cause 40 million deaths. This extreme scenario is fictitious, and no intervention will be made. Over 136 countries have already implemented health measures such as border closures, city lockdowns, and other safety measures to slow down and eventually stop the pandemic (WHO, 2019). These policies will lead to global economic depressions ( Barro et al., 2019) and spread quickly to financial markets.
In the meantime, monetary authorities are taking intensive measures to rescue these financial markets. These policies might work in the short term, as they did in the US. The unlimited QE stopped investors’ panic. These policies can create a mismatch between investors’ short-term and longer-term expectations ( Gormsen & Koijen, 2020). US policies could create more uncertainty in the global market and cause problems for emerging economies. (Chen et. al., 2016,; Tillmann 2016). Yang (2017) finds that US QE following the global financial crisis 2008 contributed to increased systemic risks at the time.
This paper presents a simple, original statistical analysis of the impact of COVID-19 on the stock market. The virus has caused thousands of deaths and posed significant challenges for countries around the globe. Financial markets have experienced unprecedented movements. Global financial market risk has increased significantly in response to the pandemic. The severity of each outbreak is correlated with the individual stock market reaction. Markets have become highly volatile and unpredictable due to the pandemic’s uncertainty and the economic losses it will cause.
Despite the need for policy responses to contain the virus, and level the stock market, unconventional policies, such as unlimited QE in the US, can create more uncertainty and cause problems over the long term. Countries need to work together to deal with these challenges. The markets of the countries studied here respond differently to the national-level policies and the overall development of the pandemic. This tendency to disintegrate the global community poses a more significant threat than the virus.