How Can COVID-19 Cause Risk Contagion?

Abstract

To explain the contagion mechanism between stock markets, we establish a two markets asset pricing model based on heterogeneous beliefs and exogenous dividends. The results show that as long as traders believe a correlation between the prices of the two markets, even if one impact of COVID-19 only affects noise traders in a single market or subjective covariance, price contagion will occur. Besides, we find that a single market dividend shock does not affect the other market. The empirical results support our analysis of the impact of COVID-19 on the stocks markets of China and the United States.