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Why Markets May React Slowly to Emerging Pandemic Risk

Article Quant Q&A · Author: user31928
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Summary

The discussion asks why major equity indexes did not fall earlier in response to emerging COVID-19 reports. One proposed explanation is that investors and even medical experts initially had limited information about the disease’s severity, transmission, and likely spread. If people viewed it as similar to seasonal flu, the perceived probability and scale of economic disruption could have remained low despite public reports of cases.

The answer also points to competing news and behavioral dynamics. Other political and economic developments may have drawn attention, while fear and selling may have intensified only as case growth made a global outbreak feel more immediate. This account connects delayed repricing with limits to what was knowable in real time and with sentiment-driven market reactions. It is a qualitative explanation, explicitly not an empirical demonstration; the discussion does not establish when prices should have adjusted or test whether the delay contradicted the semi-strong efficient market hypothesis.

Key ideas

  • Investors’ assessments depend on how severe and widespread a threat appears at the time.
  • Limited knowledge about transmission and disease severity can make the economic impact hard to estimate.
  • Competing political and economic news may reduce attention to an emerging risk.
  • Sentiment and fear can shift as visible case growth changes perceptions of the threat.
  • The answer is a retrospective hypothesis, not an empirical test of market efficiency.

Tags

EquitiesSentimentEvent-drivenUS markets
Full text
# Why didn't stock markets drop in response to COVID-19 earlier, way before Feb 21 2020?


# Why didn't stock markets drop in response to COVID-19 earlier, way before Feb 21 2020?












The S&P500 started to drop only on Feb 20 2020, and the Nikkei 225 and the FTSE 100 on Feb 21 2020. Yet as early as Jan 120, COVID-19 was reported in Hong Kong, South Korea, and Japan. Their citizens already wore masks in response, and masks' prices were gouged. Why didn't North American stocks ebb, at least a whit, in response earlier than Feb 20 2020?

- As at Feb 20 2020, commercial flights weren't suspended, and airports didn't screen or monitor arrivers. I know hindsight is 20/20, but doubtless airline passengers would spread COVID-19 worldwide from China. I agree that the extent of the spread was uncertain, but why wasn't the unquestionable existence of transmission priced in?

- Doesn't this lag contradict the semi-strong form of the EMH? I quote Zvi Bodie, Alex Kane, Alan J. Marcus's Investments (2018 11 edn). p 338.

> The semistrong-form hypothesis states that all publicly available information regarding the prospects of a firm must be reflected already in the stock price. Such information includes, in addition to past prices, fundamental data on the firm’s product line, quality of management, balance sheet composition, patents held, earnings forecasts, and accounting practices. Again, if investors have access to such information from publicly available sources, one would expect it to be reflected in stock prices.

## Answer by Hamish Gibson (score 1)

https://quant.stackexchange.com/a/53822

I cannot empirically prove this, but I have a feeling market sentiment and behavioural Economics have a larger role to play in this explanation. The consensus at the time of late-January/ early February was that COVID-19 was 'just like the flu'. The understanding of its severity was underestimated and that many people just didn't want to imagine the worst case scenario that it became a global pandemic. Again, not even medical experts knew of its incubation period, how it spread, its `r-number` etc.

Additionally, it is infeasible to try to compute the transmission rate and how far or fast it could spread too. This pandemic is most certainly one of those `black swan` moments in finance as stated by Nicholas Taleb. Where, now that it happened, it appeared 'overwhelmingly obvious' and 'how could we not have seen it coming'. At the end of the day, hindsight is only 20:20, if you pardon the pun.

Furthermore, the weighting attached to COVIDs impact was likely not that high as there were other ensuing events around the world which had more relevance at the time. Several events spring to mind, the Democratic Primaries, Brexit negotiations, slowing signs of US/global growth, Saudi/Russian oil feud, to name a few.

So, to answer your question, the moment of sullen realisation probably hadn't occurred until the world began to approach the sharp increases in cases coupled with exponential growth. This would be when Robert Shiller's 'convulsion' stage of his theory sets in and a mass panic sell of ensues. I was encourage you to read subprime solution, animal spirit and irrational exuberance where he further explores how behavioural Economic theory departs from fundamentals prescribed in the EMH.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.