COVID-19 Intensity, Resilience, and Expected Returns

This paper provides a model to interpret the relative behavior of expected returns of high- and low-resilience assets from the time of the COVID-19 pandemic, including a novel definition of disaster based on COVID-19 intensity. The setup allows us to disentangle the probability of disaster and investors’ updating probability at each point in time which sheds light on how long-memory investors react to disaster risk and play a role in future prices. The theoretical results show higher revisions in expected return differentials in the case of any perception of a higher possibility of disaster or, equivalently, higher COVID-19 intensity. The intensity of COVID-19 can directly exacerbate the heterogeneity in expected returns for high- and low-resilience assets and their corresponding differentials. More importantly, an increase in COVID-19 intensity increases the expected returns of low-resilience assets more than those of high-resilience ones.