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FDEF researchers study investor behaviour during the COVID-19 crisis

  • Faculty of Law, Economics and Finance (FDEF)
    15 June 2021

The COVID-19 pandemic has often been characterised as ‘unprecedented’ and ‘once-in-a-lifetime’ as if the rules governing its effects are just as exceptional. But is this also true for people’s reaction to it?

Researchers Thorsten Lehnert, Professor of Finance at the Department of Finance of the University of Luxembourg, doctoral student Bilal Kchouri and master student Celina Löwen used comparisons of option market implied volatility in the equity and gold markets to gain insight into how investors reacted to the pandemic. Their paper, entitled “Is this time really different? Flight-to-safety and the COVID-19 crisis,” looks at investor behaviour and weighs it against typical or expected behaviour during times of financial crisis and economic downturn.

The researchers analysed whether risk-averse investors reallocate their investments to gold, a perceived ‘safe haven’ investment as a reaction to the COVID-19 crisis. This phenomenon, referred to as a ‘flight-to-safety’, has been observed during financial crisis events, such as the crash of 2008. However, the COVID-19 pandemic was a public health crisis and not a financial one. Therefore, it remained to be seen whether investor behaviour during this event was consistent with what is known to occur during periods of financial crisis.

By studying the interconnectedness of the gold, oil and equity markets, the researchers painted a picture of aggregate investor behaviour at crucial points in time, and using causality tests, were able to infer the causes of these behaviours. While the oil market was treated as a control, researchers determined that during the COVID-19 crisis period starting in March 2020, some of the market-wide risks reflected in the equity volatility also became risks for the gold market after a brief lag. 

The increase in volatility in both markets is associated with the selling of stocks and the buying up of gold. These findings allowed the researchers to confirm that the flight-to-safety effect during the COVID-19 crisis was indeed similar to what economists had observed during other periods of financial market instability. 

To demonstrate the causal relationship between equity and gold market volatility, the researchers adopted a novel approach which differed from the symmetric causality tests that are typically employed in the literature. Using an asymmetric causality test, the researchers were able to isolate and study only the important positive changes in volatility. This more precise and realistic statistical analysis enabled the researchers to confirm flight-to-safety effects, whereas the traditional symmetric causality test would have led them to the wrong conclusion. 

The paper is available free to download in the open access journal PLOS ONE.