Pandemic Tail Risk

Abstract

This paper studies the tail risk of US equity markets in advance of the COVID-19 outbreak in February 2020, providing evidence that financial markets are informative about pandemic risk well in advance of the actual outbreak. Specifically, while the tail risk of the market index did not respond before the outbreak, we document that the tail risk of less pandemic-resilient economic sectors boomed in advance. This result is robust to alternative specifications of tail risk measured from either option or credit default swap contracts. Long-horizon tail risk measures provide information about investors' perception of pandemic risk persistence and economic recovery.

Keywords: COVID-19, tail risk, economic sectors

JEL Classification: G01, G10, G12, G14