Measuring the psychological impact of a health pandemic on stock markets
Stock markets around the world have taken significant and historic levels of damage this week due to the rapid spread of COVID-19 across the world.
Market volatility led to the biggest single-day fall since in 1987 as 10.87 percent was wiped from the value of the FTSE 100.
Cass Professor of Organisational Behaviour André Spicer explains that this highly volatile behaviour of the markets is caused by more than just issues of supply and demand:
"Health epidemics and pandemics evidently hit markets hard through economic fundamentals, but they can powerfully influence investor psychology as well."
"We know that demand for many products decreases throughout a highly contagious spread as people don't consume products and services like travel or entertainment. The supply of this also drops as people become sick or have to stay home to care for others, so overall the total labour force and therefore level of production decreases.
"It is also worth considering that epidemics can have a psychological impact on markets, for several reasons.
"Firstly, they can distract people working in financial markets, meaning they make more mistakes when predicting crises. When these people or their loved ones are ill, their minds are likely to be elsewhere and this can impact decision-making and predictions about future prices.
"Secondly, when people think that pathogen levels are high and there is a greater risk to their health, they tend to become more conservative, less outgoing, less innovative, and compliant with authorities. This means people are likely get rid of anything they would see as a risky bet and run for safety—again impeding their judgment.
"Thirdly, traders begin to react when an epidemic reaches their own doorstep. For instance, we know that when flu hits areas where global trading activity is located—such as London and New York—the amount of trading activity tends to go down as people are off sick.
"Lastly, when there are large movements in markets, traders tend to become stressed. Under conditions of stress people are more likely to rely on various cognitive biases, such as herding or being loss averse, rather than analyzing their options more rationally."