The effect of the Covid pandemic on stock market volatility: Separating initial impact from time-to-recovery

We develop an extension to the GARCHX model - named GARCHX-NL - that captures a key stylised fact for stock market return data seen during the Covid pandemic: an abrupt jump in volatility at the onset of the crisis, followed by a gradual return to its pre-crisis level. We apply the GARCHX-NL procedure to daily data on various major stock market indexes. The profile likelihood method is used for estimation. The model decomposes the overall impact of the crisis into two measures: the initial impact; and the "half-life" of the shock. We find a strong negative association between these two measures. Moreover, countries with low initial impact but a long half-life tend to be emerging markets, while those with high initial impact and short half-life tend to be developed economies with well established stock-markets. We attribute these differences to differences in investors' sensitivity to adverse news, and to differences in the preparedness of stock markets to absorb the effects of crises such as the Covid19