The Systematic Risk of Global Asset Returns in Times of Crisis: (How) is COVID-19 Different?

Abstract

Using high-frequency data, we estimate and characterize the evolution of the factor structure of global asset returns across aggregate equity, fixed income and exchange rates over the period 2007-2020. We show how the factor structure of asset returns evolves through time, providing clear identification of the first two principal components (PC). Of some interest, we show these PC factor returns are subject to sudden and temporary changes in their structure, linking these changes to well-known crises (e.g., Covid-19 pandemic, Global Financial Crisis, and Brexit). These crisis periods have common features. Because of the exogenous nature of the Covid-19 shocks, we identify the drivers of the changing PC structure using news/shocks about the virus and epidemiological model forecast errors. We then investigate the implications of these findings for popular asset portfolios, with a particular focus on the volatility of these portfolios and their systematic risk exposure. Interestingly, the ability to diversify country asset-specific risk and hedge systematic risk is greatly reduced during the peak of crisis periods.