New economic modeling explains why stock prices continue to climb during a pandemic
By Braden McMillan
Despite facing huge economic uncertainty and the worst global health crisis in over a century, many economists and market participants have been puzzled by how quickly, and completely, stock prices have rebounded from their earlier crash. To help explain this phenomenon, SFU economist Lucas Herrenbrueck has published a white paper with economic modeling that illustrates how asset prices are high because of the pandemic, not despite it.
While standard asset pricing models typically predict price declines during a recession, Herrenbrueck’s new modeling suggests that this is not the case during a recession caused by consumption restrictions, such as those currently being imposed around the world. Instead, the restrictions are actually reducing the value of having income right now, and thereby driving asset prices up, to an extent that has now overcome the initial impact caused by the recession.
“With physical distancing measures in place, many people are spending less on things like travelling, eating out or attending concerts and other social gatherings,” says Herrenbrueck. “Instead, those who are still earning a regular income are staying home and turning their attention to investments including stocks, bonds and real estate.”
Herrenbrueck notes that even if the lower spending pulls down incomes with it, so that people on average don’t necessarily have more resources to invest, the desire to save and invest has gone up and that alone is enough to make asset prices increase.
“To put it simply, the pandemic has increased demand for saving instruments, including stocks and bonds, while at the same time reduced our opportunities to spend on other things. This combination is contributing to higher asset prices despite poor economic conditions.”
According to Herrenbrueck, this modeling is dependent on the pandemic not lasting longer than a few years and requires the consumption restrictions be at least as severe as restrictions on supply. The results are also not connected to central bank interventions in asset markets since the demand for saving instruments is high, driving prices up, even without the interventions.
Herrenbrueck’s white paper, Why a pandemic recession should boost asset prices (. . . according to standard economic theory), can be read online.