Implications of Stochastic Transmission Rates for Managing Pandemic Risks

Review of Financial Studies forthcoming

52 Pages Posted: 13 May 2020 Last revised: 13 Oct 2020

See all articles by Harrison G. Hong

Harrison G. Hong

Columbia University, Graduate School of Arts and Sciences, Department of Economics; National Bureau of Economic Research (NBER)

Neng Wang

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Jinqiang Yang

Shanghai University of Finance and Economics

Multiple version iconThere are 2 versions of this paper

Date Written: September 13, 2020

Abstract

We develop a model of pandemic risk management and firm valuation. We introduce aggregate transmission shocks into an epidemic model and link valuations to infections by using an asset-pricing framework that accounts for vaccines. Infections lower earnings growth but firms can mitigate damages. We estimate a large reproduction number R_0 and transmission volatility for COVID-19. Using these estimates, we assess the accuracy of deterministic approximations based on R_0. Our model generates predictions consistent with data: unexpected infection resurgence, non-monotonic mitigation policies and higher price-to-earnings ratios during a pandemic. Stock market values would be significantly lower absent mitigation and a high vaccine arrival rate.

Keywords: COVID-19, stochastic epidemic model, risk management, stock valuation

JEL Classification: G12, I10, G31, E30

Suggested Citation

Hong, Harrison G. and Wang, Neng and Yang, Jinqiang, Implications of Stochastic Transmission Rates for Managing Pandemic Risks (September 13, 2020). Review of Financial Studies forthcoming, Available at SSRN: https://ssrn.com/abstract=3599599 or http://dx.doi.org/10.2139/ssrn.3599599

Harrison G. Hong (Contact Author)

Columbia University, Graduate School of Arts and Sciences, Department of Economics ( email )

420 W. 118th Street
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Neng Wang

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jinqiang Yang

Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, P.R.China, AK Shanghai 200433
China

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