Systematic COVID risk, idiosyncratic COVID risk and stock returns

This paper proposes an event-based approach to estimate the systematic and idiosyncratic COVID risk for individual stocks. The systematic COVID risk is based on the excess co-variance between stock returns and market returns during the event window when the COVID shock occurred. The idiosyncratic COVID risk is based on the excess idiosyncratic volatility during the event window. The approach also allows us to estimate abnormal returns associated with COVID shock for individual stocks. Moreover, we apply the event-based approach to separately estimate the risks associated with domestic COVID shock and foreign COVID shock. Based on the estimates of COVID risk and abnormal COVID returns, we examine their relations with future stock returns. Our results show that both systematic domestic and foreign COVID risks are positively related to future stock returns, suggesting that investors demand higher expected returns for stocks with high exposure to the COVID shock. We also find a negative relation between abnormal returns associated with domestic COVID and future stock returns and the relation becomes stronger over longer horizon, indicating initial overreaction to COVID shock. We perform various robustness checks to confirm our main findings. Our findings have important implications on risk management for investors, firms, and regulators.