COVID-19 and the Discounting of Real Economic Activity in the U.S. and European Stock Markets

Abstract

Using an extended version of the Gordon dividend discount model, the large falls in the U.S. and European stock market assets at the beginning of the COVID-19 pandemic are found to be the result of pricing expected future falls in real economic activity caused by the global shock. The subsequent boom in asset markets and reductions in volatility immediately following this initial fall in stock prices are caused by a strong connection of the central banks' balance sheet extension to the near-term stock market uncertainty. This connection of unconventional monetary policy actions is strongly priced in the U.S. and European markets.

Keywords: COVID-19, discounting, stock markets, macro factors, rare disasters, tail risk, unconventional monetary policy

JEL Classification: C54, C58, E32, E44, E58, G01, G12