Financial Market Reaction to Dramatic Public Health Shocks
CHEN Yun, SHEN Yan, WANG Jingyi
School of Banking and Finance, University of International Business and Economics;National School of Development, Peking University; School of Finance, Central University of Finance and Economics
Summary:
How financial markets react to public health shocks as dramatic as a global pandemic is an important issue for the well-being of investors and even for the financial stability of a country. The COVID-19 global pandemic that began at the end of 2019 provides an opportunity to examine such reactions. In addition to the significant social changes brought by COVID-19,the normal operation and development of firms has been put under pressure in terms of the dilemma between “fighting the epidemic” and “work resumption.” In this study, we examine the relationship between the capabilities of urban public governance, investor sentiment, and stock price in the context of the COVID-19 outbreak, and address two main issues. The first issue is whether important information related to the outbreak, such as urban public governance capacity, can be perceived by retail investors during an outbreak. The second issue is whether the information above will be priced by the stock market. We examine the impact of urban public governance capacity on the stock market through investigating the effectiveness of epidemic prevention measures and the resumption of work. The ability to publicly govern in the urban context can affect stock returns by influencing investor sentiment and corporate fundamentals. If a listed firm is located in a region where there is effective epidemic prevention, the anxiety of its investors is likely to be alleviated. The noise trading theory (De Long et al., 1990) suggests that pessimistic investor sentiment will lead to low stock returns in the future. However, in terms of a firm's operation fundamentals, the ability to ensure work resumption directly determines how quickly a firm can restore its normal operations, which in turn affects the stock return. This effect will be stronger for small- and medium-sized and growth-type firms, which are more vulnerable, and for those situated in areas with poor digital financial infrastructure. We first collect data from several channels to measure investor sentiment, regional epidemic prevention ability, and capacity for work resumption during the COVID-19 outbreak. Investor sentiment is then measured by examining the text of around 2.6 million Internet forum posts, and regional epidemic prevention ability using real-time data of the number of hospital buildings per capita, obtained from AutoNavi Map. We measure the capacity for work resumption using real-time data of the movement of the population in and out of each location examined, which is obtained from the Baidu Migration Index.To assess the sensitivity of investors to information about public governance capacity, we estimate whether the capacity of a region in which a listed company is located can predict investor sentiment. Finally, we estimate the impact of investor sentiment and the ability for epidemic prevention and work to resume on stock returns during the first week after the Spring Festival. Additional analyses of the mechanisms are conducted by examining the dimensions of firm size, firm type (growth-type or value-type), and the strength of the local digital infrastructure. Our main findings are as follows. First, investor sentiment is affected by a region's ability to prevent epidemics but is not sensitive to a region's ability of work resumption. Second, during the epidemic higher levels of investor sentiment and a greater ability to ensure work resumes both predict higher stock returns. However, regional epidemic prevention ability has no significant effect on firms' stock returns. Third, the effect of the ability of work resumption on stock returns is greater for small firms, growth-type firms, and those with poor digital financial infrastructure. Our study makes three main contributions to the literature. First, we are probably the first to examine the relationship between urban public governance capacity and the reactions of the Chinese stock market during the COVID-19 outbreak. Second, we directly test whether investors can evaluate the capacity of urban public governance during major public events. Third, most studies on the impact of digital finance on the economy and investment focus on non-disaster periods. Our study extends this research by examining the role of digital finance during a disaster period. Our findings suggest that digital finance has a stabilizing role and we highlight the importance of its further development.
Antweiler, W. and M. Z. Frank, 2004, “Is All That Talk Just Noise？ The Information Content of Internet Stock Message Boards”, Journal of Finance, 59(3), pp. 1259～1294.
[9]
Baker, M. and J. Wurgler, 2006, “Investor Sentiment and the Cross‐Section of Stock Returns”, Journal of Finance, 61(4), pp. 1645～1680.
[10]
Benson, C. and E.J. Clay, 2004, “Understanding the Economic and Financial Impacts of Natural Disasters”, World Bank Publications Series, No. 4.
[11]
Bergholt, D. and P. Lujala, 2012, “Climate-related Natural Disasters, Economic Growth, and Armed Civil Conflict”, Journal of Peace Research, 49(1), pp. 147～162.
[12]
Cavallo, E., S. Galiani, I. Noy and J. Pantano, 2013, “Catastrophic Natural Disasters and Economic Growth”, Review of Economics and Statistics, 95(5), pp. 1549～1561.
[13]
Cuaresma, J. C., J. Hlouskova and M. Obersteiner, 2008, “Natural Disasters as Creative Destruction？ Evidence from Developing Countries”, Economic Inquiry, 46(2), pp. 214～226.
[14]
De Long, J. B., A. Shleifer, L. H. Summers and R. J. Waldmann, 1990, “Noise Trader Risk in Financial Markets”, Journal of Political Economy, 98(4), pp. 703～738.
[15]
Hanna D. and Y. Huang, 2004, “The Impact of SARS on Asian Economies”, Asian Economic Papers, 3(1): pp. 102～112.
[16]
Hood, M., A. Kamesaka, J. Nofsinger and T. Tamura, 2013, “Investor Response to a Natural Disaster: Evidence from Japan's 2011 Earthquake”, Pacific Basin Finance Journal, 25, pp. 240～252.
[17]
Huang, Y., Y. Li and H. Shan, 2018, “Fintech and Firm Selection: Evidence from E-commerce Platform Lending”, Working Paper.
[18]
Kaplanski, G. and H. Levy, 2010, “Sentiment and Stock Prices: the Case of Aviation Disasters”, Journal of Financial Economics, 95(2), pp. 174～201.
[19]
Li, J., Y. Chen, Y. Shen, J. Wang and Z. Huang, 2019, “Measuring China's Stock Market Sentiment”, Working paper.
[20]
Li, R., S. Qi and H. Sun, 2020, “A Lender in Need Is a Lender Indeed: Evidence from Fintech and Bank Lending after Natural Disasters”, Working Paper.
[21]
Liu, J., R. F. Stambaugh and Y. Yuan, 2019, “Size and Value in China”, Journal of Financial Economics, 134(1), pp. 48～69.
[22]
Noy, I., 2009, “The Macroeconomic Consequences of Disasters”, Journal of Development Economics, 88(2), pp. 221～231.
[23]
Shelor R. M., D. C. Anderson and M. L. Cross, 1990, “The Impact of the California Earthquake on Real Estate Firms' Stock Value”, Journal of Real Estate Research, 5 (3), pp. 335～340.
[24]
Skidmore, M. and H. Toya, 2002, “Do Natural Disasters Promote Long‐run Growth？”, Economic Inquiry, 40(4), pp. 664～687.
[25]
Worthington, A. and A. Valadkhani, 2004, “Measuring the Impact of Natural Disasters on Capital Markets: An Empirical Application Using Intervention Analysis”, Applied Economics, 36(19), pp. 2177～2186.
