The corona spreads

Rui Esteves, Nathan Sussman 18 April 2020



The widespread nature of the global health emergency has spurred an active debate on the economic implications of the COVID-19 pandemic, and the required policy reaction to ‘flatten the curve’ — both the epidemiological curve, and the curve of the inevitable recession that accompanies it (Gourinchas 2020).

The implications of this large coordinated shock for financial stability are also under scrutiny, with the focal point of financial fragility located outside the banking sector, unlike in 2008 (Danielsson et al. 2020, Acharya and Steffen 2020). Nevertheless, more than a decade of liquidity injections by central banks have resulted in a highly leveraged corporate sector. This leaves firms fragile to a credit crunch, even in the case of the shadow banking sector (Goodhart and Pradhan 2020, Danielsson et al. 2020). In this setting, conventional monetary policy (already hampered by the ‘zero lower bound’) and even the unconventional policies (put in place after the Global Crisis) may not be up to the task (Cochrane 2020).

Accordingly, targeted fiscal measures via income guarantees or ‘bridge funding’ to companies should take precedence over liquidity support to the financial sector via central banks (Ilzetki 2020, Barwell et al. 2020). As was demonstrated in the wake of the Global Crisis, policymakers should consider the externalities of their actions, both in terms of public health and economic policies. There is a call for international coordination to cushion the economic downturn and restart the global economy (Berglöf and Farrar 2020, Group of Concerned Economists 2020). The nature of the worldwide shock should determine the priorities in terms of cooperation — namely, coordinated fiscal stimuli or monetary easing (e.g. via central bank ‘swap lines’).

In a new paper (Esteves and Sussman 2020), we take a cue from the initial reaction of financial markets to the unfolding medical emergency to identify the nature of the financial shock, and the policy implications that follow.

How markets priced COVID-19

The COVID-19 virus first appeared in Wuhan (China) in December 2019. Until February 2020, when the virus then erupted in Italy, the threat to the global economy was thought to be minor. As the virus spread across Europe, and countries reacted with partial lockdowns, it became clear that the global economy was now facing a major crisis. Internationally, financial markets reacted strongly by the end of February 2020 (Figure 1). A formal ‘break’ points to 10 March 2020 , when the ‘end of year rally’ that began in October 2019 fully reversed itself.

Figure 1 SP500 January 2019-April 13,2020

The crisis was felt in all major financial asset markets. The Morgan Stanley Capital International (MSCI) world stock price index mirrored Wall Street (Figure 2). However, it declined more and recovered less ground. The yield on ten-year bond prices (with the exception of the US) increased (Figure 3), and a significant spread has opened between the advanced- and the emerging-market bond yields. In the foreign exchange market, most currencies depreciated against to the US dollar (Figure 4). While the exchange rate of the US dollar with the major currencies (DXY) has recovered, the basket of emerging-market currencies remains depreciated.

Figure 2 World Stock Prices

Figure 3 10 Year Bond Yields

Figure 4 Exchange rates

The data from financial markets looks very similar to the beginning of previous global recessions. Indeed, most of the immediate responses (mainly from central banks) echo those of 2008, albeit with a much shorter time lag. Though the US is not immune to the COVID-19 pandemic, now as was then, US assets provide a safe haven in times of international economic crisis (Corsetti and Marin 2020). As before, emerging-markets' financial assets seem to exhibit larger price decline. As a result, the role of the Federal Reserve in supplying global liquidity is paramount. The question is: which countries require help the most help the most urgently?

Market efficiency during COVID-19

In this context, we test whether we are facing the 'usual' financial meltdown that is reinforced by contagion and scramble for liquidity, or whether markets price the severity of the COVID-19 impact on various economies. We look at the immediate reaction of financial markets using daily data for the period from 17 February to 23 March 2020. Since we are dealing with a very short time period, we used a cross section analysis examining the factors that affect financial assets' prices during this period. The dynamic (or time-varying) aspect of our data is the death toll from COVID-19, which varies by country according to the timing and extent of their exposure to the virus. Our null hypothesis is that countries that are exposed more severely to the virus will suffer greater asset price declines, conditional on their pre-crisis characteristics.

Since financial markets are inherently forward-looking, we also examine whether markets are pricing the ‘likely’ trajectory of the virus in various countries, rather than the 'historical' impact of the virus. Specifically, we test whether the change in asset prices between the 17 February and 21 March 2020 reacts to contemporary coronavirus death statistics, or to future death rates.

We examined three measures of financial stress: (1) the change in a country’s ten-year bond spread with respect to the US level, (2) the depreciation of the domestic currency against the US dollar, and (3) the volatility of the exchange rate with respect to the US dollar.

Our results clearly show that financial markets incorporate the dynamics of the pandemic as a future (rather than real-time) shock. Death rates (per million) do not affect the prices and the volatility of financial assets. However, extrapolated future deaths do. Consistent with ongoing media coverage of exponential trends, we extrapolate the death rates for the week starting on 22 March 2020 from the exponential trend in deaths in the week prior.1 This may help to explain the unprecedented severity of reaction of markets to COVID-19, at least when compared with previous pandemics (Baker et al. 2020). Markets were pricing the future ‘likely’ trend in deaths, rather than past death rates.

Figure 5 illustrates the results for ten-year bond spreads by plotting the marginal effects (in basis points) of proportional changes across four variables. The estimates themselves are distinguished by OECD membership. A 1% increase in extrapolated death rates adds ten basis points to spreads, but only for emerging countries. This is statistically significant but quantitatively small when compared with the direct effect of currency devaluation on yields (a currency risk channel).2

Figure 5 Average marginal effects on 10 year bond spreads

We document similar effects for the other two measures of financial stress (currency devaluation and volatility), which are smaller for advanced (OECD) economies (even more so for members of the euro area). Membership in a currency-bloc may provide member economies with more liquidity and financial resources than for non-aligned economies, especially if in the ‘emerging’ group.

Policy implications

The effect of the deaths from the virus are significant, yet they explain only a small fraction of the variance in asset prices over our period of investigation. As a result, the treatment (especially by central banks) of this episode as ‘yet another global financial crisis’ is appropriate. Once again, the crisis exposes the vulnerabilities of emerging-markets to global shocks even though their death rates are lower, emphasising the need to build up liquidity reserves. Our results also highlight the benefits from belonging to an exchange rate bloc that can provide liquidity.

Finally, before the crisis the financial community and economists were deeply (and perhaps overly) interested in cryptocurrencies. This was the first market test under duress for these currencies. Figure 6 demonstrates that cryptocurrencies reacted very sharply to the crisis. This highlights the fact that cryptocurrencies offer no hedge against global financial crises. Despite massive injections of liquidity by the Federal Reserve, there has been no run against the US dollar in favour of cryptocurrencies.

Figure 6 Bitcoin, USD price

What about allegedly stable currencies such as Libra? Again, the crisis highlights the need for monetary authorities that can immediately inject liquidity and support fiscal efforts to provide for millions of quarantined households. As the Great Depression famously showed, fixed exchange standards and links to gold compound the economic costs of global macro-shocks (Eichengreen 1992). The case for credible (but flexible) sovereign currencies seems to have been strengthened by this pandemic. At best, Libra and similar products could be yet another financial asset. They are not what money is about, and this is why society invented it and entrusted its management to central banks.


Acharya, V and S Steffen (2020), “Stress tests’ for banks as liquidity insurers in a time of COVID”,, 22 March .

Baker, S, N Bloom, S Davis, K Kost, M Sammon and T Viratyosin (2020), “The unprecedented stock market reaction to Covid-19”, Covid Economics Vetted And Real-Time Papers 1: 33-42.

Barwell, R, J Chadha and M Grady (2020), “COVID-19 crisis: Fiscal policy should lead and the Bank of England should follow for the duration of the crisis”,, 29 March.

Berglöf, E and J Farrar (2020), “The COVID-19 pandemic: A letter to G20 leaders”,, 26 March.

Corsetti, G and E Marin (2020), “The dollar and international capital flows in the COVID-19 crisis”,, 2 April.

Danielsson, J, R Macrae, D Vayanos and J-P Zigrand (2020), “The coronavirus crisis is no 2008”,, 26 March.

Eichengreen, B (1992) Golden Fetters The Gold Standard and the Great Depression, 1919–1939, New York: Oxford University Press.

Esteves, R and N Sussman (2020), “Corona Spreads”, Graduate Institute, Geneva, Mimeo.

Goodhart, C and M Pradhan (2020), “Future imperfect after coronavirus”,, 27 March.

Gourinchas, P-O (2020), “Flattening the pandemic and recession curves” in Baldwin, R. and B. Weder de Mauro (eds.) Mitigating the COVID Economic Crisis: Act Fast and Do Whatever It Takes, CEPR: eBook: 31-41.

Group of concerned economists (2020), “The European Union and democracy must deliver”,, 16 March.

Ilzetzki, E (2020) “COVID-19: The economic policy response”,, 28 March.


1 We argue that it is reasonable to assume that the direction of causality runs from future virus deaths to current financial assets' prices. We feel confident in testing for the future impact of the virus because the information on the virus's spread and impact on mortality is widely and publicly available and the various websites provide readily accessible per-capita measures as well as dynamic analysis (logarithmic figures, etc). 2 Debt/GDP ratios and starting values of yields are not significant.



Topics:  Covid-19 Financial markets

Tags:  COVID-19, Central Banks, financial crises, emerging markets

Associate Professor of International History, Graduate Institute Geneva

Professor of Economics, The Graduate Institute, Geneva


CEPR Policy Research