Investors’ risk attitudes in the pandemic: Stock markets are less sensitive in jurisdictions that have restricted mobility less and that have enacted other containment measures against the pandemic

Investors’ risk attitudes in the pandemic and the stock market: new evidence based on internet searches. Marlene Amstad, Giulio Cornelli, Leonardo Gambacorta and Dora Xia. BIS Bulletin No. 25. https://www.bis.org/publ/bisbull25.htm

Key takeaways
• The sharp drop and subsequent rebound in global stock markets in the current pandemic focuses attention on changes in investors’ risk attitudes.
• A new Covid-19 risk attitude (CRA) index for 61 markets, based on internet searches in Google and Baidu, does a good job at capturing investors’ attitudes toward pandemic-related risks.
• Stock markets are more sensitive to changes in the CRA index in more financially developed economies. Stock markets are less sensitive in jurisdictions that have restricted mobility less and that have enacted other containment measures against the pandemic.

1. Introduction
The Covid-19 crisis has left a deep mark on stock markets, with a fall in prices similar to those experienced during the Great Depression in 1929, and a subsequent rebound. The observed equity price reaction relates to changes in traditional drivers such as relative price shifts and risk aversion measures, but it could also reflect changes in investors’ attitude towards risk in the pandemic.1 The aim of this Bulletin is to use information on internet searches on Google and Baidu to derive a measure of stock market investors’ concerns about the pandemic and to assess how such a measure could explain the sharp drop and subsequent rebound in stock markets. We focus on the initial period of the Covid-19 pandemic, covering up to end-April 2020.

The role of investors’ risk attitude could be particularly relevant in a time of sudden large shocks and when fundamental drivers suffer from higher uncertainty. The US Economic Policy Uncertainty index has peaked in April 2020 at levels more than twice as high as previous records (Baker et al (2020)). Shiller (2020) even sees Covid-19 as two pandemics – one in the real economy, and the other in the perception of the impact the first one might have. However, while the impact of fundamental drivers on US stock returns during the pandemic has already been studied (Ding et al (2020) and Alfaro et al (2020)), the role of investors’ risk attitudes has received less attention.

The analysis in this Bulletin focuses on mid-February to end-April 2020, including an initial period of severe sell-off in global equity markets (until mid-March), as well as a recovery – in some cases by almost half of the previous drop – from then to end-April. We show that traditional drivers of equity markets – such as changes in the value of the US dollar, oil prices, measures of risk aversion – and the unconventional monetary policy measures adopted are not able to fully capture the evolution of stock market prices during this period. To study the evolution of investors’ risk attitude towards the pandemic, we construct for each market a new “Covid-19 risk attitude” (CRA) index, based on the number of internet searches in different markets. The idea is that web searches for terms related to Covid-19 reflect people’s concern about the pandemic and its economic consequences. Interestingly, during the first months of the pandemic the CRA index foreshadowed the actual number of recorded infections globally. This indicates that for investors the economic effects of the pandemic are globally linked and are not confined to the areas directly affected by the virus. From the last week of March until the end of April, a fall in the CRA index reflects a reduction in investors’ concern and goes hand in hand with the recovery in equity prices.

Results indicate that investors’ risk attitude as captured by internet searches played a significant role in most stock markets over and above what is explained by other more traditional drivers. On average, the CRA index explains an additional 6% of the observed equity price variation in the sample period.2 In particular, stock markets are more sensitive to changes in the CRA index in more financially developed economies. Markets are less sensitive in those jurisdictions that have restricted mobility by less and have enacted other containment measures against the pandemic.