Sovereign Debt and Equity Returns in the Face of Disaster
48 Pages Posted: 10 Apr 2020 Last revised: 12 Nov 2021
Date Written: September 15, 2020
We study the role of sovereign debt for equity returns in the Covid-19 pandemic. Using individual stock-level data of more than 25,000 firms in more than 80 countries, we exploit variation in debt-to-GDP in narrowly defined industries and geographical regions. Following the outbreak of the pandemic, cumulative returns and cumulative CAPM-adjusted abnormal returns are lower in countries with higher debt-to-GDP ratios. Variation in debt-to-GDP explains around 23% of the average stock price decline in the initial phase of the pandemic. While corporate default risk rises, we find little evidence that debt-to-GDP captures uncertainty across countries. As the pandemic evolves, we further show that abnormal returns drop more in response to the same growth in infections among high- compared to low-debt-to-GDP countries. Our results are robust to a host of firm- and country-level controls, including sovereign credit ratings. Overall, sovereign debt is a key determinant of equity risk in the face of disaster.
Keywords: Sovereign debt, debt-to-GDP, disaster, COVID-19, firm-level equity returns, cross-country effects
JEL Classification: F30, G12, G14, G15, H12, H50, H63
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