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Preventing Crash in Stock Market: the Role of Economic Policy Uncertainty During COVID-19

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Preventing Crash in Stock Market: the Role of Economic Policy Uncertainty During COVID-19 A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Dai, Peng-Fei; Xiong, Xiong; Liu, Zhifeng; Toan Luu Duc Huynh; Sun, Jianjun Article Preventing crash in stock market: The role of economic policy uncertainty during COVID-19 Financial Innovation Provided in Cooperation with: SpringerOpen Suggested Citation: Dai, Peng-Fei; Xiong, Xiong; Liu, Zhifeng; Toan Luu Duc Huynh; Sun, Jianjun (2021) : Preventing crash in stock market: The role of economic policy uncertainty during COVID-19, Financial Innovation, ISSN 2199-4730, Springer, Heidelberg, Vol. 7, Iss. 1, pp. 1-15, http://dx.doi.org/10.1186/s40854-021-00248-y This Version is available at: http://hdl.handle.net/10419/237262 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle You are not to copy documents for public or commercial Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich purposes, to exhibit the documents publicly, to make them machen, vertreiben oder anderweitig nutzen. publicly available on the internet, or to distribute or otherwise use the documents in public. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ www.econstor.eu Dai et al. Financ Innov (2021) 7:31 https://doi.org/10.1186/s40854‑021‑00248‑y Financial Innovation RESEARCH Open Access Preventing crash in stock market: The role of economic policy uncertainty during COVID‑19 Peng‑Fei Dai1,2, Xiong Xiong1, Zhifeng Liu3* , Toan Luu Duc Huynh4,5 and Jianjun Sun6 *Correspondence: [email protected] Abstract 3 Management School, This paper investigates the impact of economic policy uncertainty (EPU) on the crash Hainan University, Haikou, China risk of US stock market during the COVID‑19 pandemic. To this end, we use the GARCH‑ Full list of author information S (GARCH with skewness) model to estimate daily skewness as a proxy for the stock is available at the end of the market crash risk. The empirical results show the signifcantly negative correlation article between EPU and stock market crash risk, indicating the aggravation of EPU increase the crash risk. Moreover, the negative correlation gets stronger after the global COVID‑ 19 outbreak, which shows the crash risk of the US stock market will be more afected by EPU during the epidemic. Keywords: COVID‑19, Economic policy uncertainty, Crash risk, Skewness JEL Classifcation: D80, E60, G10, G32 Introduction Te economic downturn during the COVID-19 pandemic has resulted in a signif- cant decline in the stock market. Some of the previous studies have examined the impacts of COVID-19 pandemic on the downside risks of stock market. One of the main conclusions is that, in general, the occurrence of COVID-19 causes a direct and signifcant drop in stock prices (Baker et al. 2020b, a; Al-Awadhi et al. 2020; Ramelli and Wagner 2020; Zhang et al. 2020; Liu et al. 2020). Djurovic et al. (2020) points the Dow Jones Industrial Index has been dropping by 36.4% between February 18, 2020 and March 23, 2020. While from the perspective of volatility risk, COVID-19 will signifcantly increase the volatility of the stock market (Baek et al. 2020; Onali 2020; Papadamou et al. 2020). Diferent from the existing literature, this paper focuses on stock market crash risk. Mazur et al. (2020) and Ziemba (2020) study the US stock market crash during the Covid-19 period. However, they treat the crash risk as the extreme downside volatility. In our paper, following Chen et al. (2001) and Kräu- ssl et al. (2016), we measure the crash risk by using the conditional skewness of the equity market return. It is a better way to simultaneously capture the asymmetry and negative extremes of the crash risk (Kim et al. 2011a, b; Kim et al. 2011b; Wen et al. © The Author(s), 2021. Open Access This article is licensed under a Creative Commons Attribution 4.0 International License, which permits use, sharing, adaptation, distribution and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons licence, and indicate if changes were made. The images or other third party material in this article are included in the article’s Creative Commons licence, unless indicated otherwise in a credit line to the mate‑ rial. If material is not included in the article’s Creative Commons licence and your intended use is not permitted by statutory regulation or exceeds the permitted use, you will need to obtain permission directly from the copyright holder. To view a copy of this licence, visit http:// creat iveco mmons. org/ licen ses/ by/4. 0/. Dai et al. Financ Innov (2021) 7:31 Page 2 of 15 3,600 Daily New Confirmed Cases (Left Axis) S&P 500 (Right Axis) 3,400 80,000 3,200 70,000 3,000 60,000 2,800 50,000 2,600 40,000 2,400 30,000 20,000 2,200 10,000 0 10 06 21 6 31 26 19 8 13 07 -01- -04- -07-03 -09-27 -12- -03-21 -09-11 12-0 -03-06 -05- -08- -11- -05- 17 17 17 17 17 18 18-06-1518 8- 19 19 19 19 0-02-120 0-08- 20 20 20 20 20 20 20 20 201 20 20 20 20 202 20 202 Fig. 1 Daily new confrmed cases and S&P 500 Index 2019a, b). And then, we conduct an empirical analysis to investigate the impacts of the economic policy uncertainty on the crash risk of the US stock market. In fact, in the early days of the pandemic, the US stock market has experienced a plunge. From Fig. 1, we can see that the stock market has undergone a severe impact from COVID-19. Te S&P 500 plummets by one-third in a short period, from 3380 points on February 14, 2020 to 2237 points on March 23, 2020. Our subsequent empirical fndings further confrm this intuitive conclusion that COVID-19 negatively afects stock market crash risk. We fnd that the severity of the pandemic, whose proxy is the growth rate of the daily new confrmed cases, does have a signifcant neg- ative impact on the conditional skewness of the market return, i.e., the crash risk of stock market. It is also consistent with Liu et al. (2021)’s work on the Chinese equity market, which indicates that the pandemic increases the crash risk of stock market. However, we have noticed that although the number of daily confrmed cases in the United States continued to rise in the following period, stock prices gradually returned to the level before the pandemic, and even hit a new high in the past three years. It indicates that the severity of the pandemic alone is not enough to explain the stock crash. We argue that one of the reasons for this situation is the reduction of uncertainty in economic policies, which is believed to have a wide-ranging impact on economic and fnancial activities (Gulen and Ion 2016; Brogaard and Detzel 2015; Dai et al. 2021; Wen et al. 2019a, b; Yousaf and Ali 2020). Figure 2 illustrates the evolving curves of uncertainty indices and S&P 500. As we can see from Fig. 2, during the pandemic, economic policy uncertainty (EPU) and stock prices display the opposite trend. In the early stages of the pandemic, as the uncertainty caused by COVID-19 rose sharply, stock prices have also sufered a crash. However, with the successive gov- ernment measures designed to deal with the pandemic, economic policy uncertainty Dai et al. Financ Innov (2021) 7:31 Page 3 of 15 3,600 Economic Policy Uncertainty Index (Left Axis) 3,400 Equity Market-related Economic Uncertainty Index (Left Axis) Equity Market Volatility: Infectious Disease Tracker (Left Axis) 3,200 S&P 500 (Right Axis) 3,000 2,800 2,600 2,400 1,000 2,200 800 600 400 200 0 10 03 27 1 5 6 6 31 9 8 07 2-2 6-1 -0 - 1-1 2-1 - -01- -04-06 -07- -09- -1 -03-21 -0 -09-11 -1 -0 -05-13 17 17 17 17 17 18 18 18 8-12-0 9-03 9-05 9-08-2619 20 20 0-08 20 20 20 20 20 20 20 20 201 201 201 201 20 20 20 202 Fig. 2 Economic policy uncertainty and the S&P 500 Index has gradually decreased, which is what we believe a fundamental reason for the stock market rebound. In other words, we believe that the reduction of economic policy uncertainty during the pandemic will help reduce the crash risk of stock market. Our fndings also support this hypothesis. We fnd that the conditional skewness reacts negatively to the change rate of economic policy uncertainty, indicating that the reduction of economic policy uncertainty can efectively reduce the crash risk of stock market. We further fnd that this efect only exists during the pandemic, and it is not signifcant during regular periods. It may mean that the stability of economic policies plays a more critical role in reducing the extremely negative impact of major crisis events.
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