International Review of Financial Analysis 70 (2020) 101496

Contents lists available at ScienceDirect

International Review of Financial Analysis

journal homepage: www.elsevier.com/locate/irfa

COVID-19 pandemic, oil prices, stock market, geopolitical risk and policy T
uncertainty nexus in the US economy: Fresh evidence from the wavelet-
based approach
Arshian Sharifa,d, Chaker Alouib, Larisa Yarovayac,
⁎

a
Othman Yeop Abdullah Graduate School of Business, University Utara Malaysia, Malaysia
b
College of Business Administration, Prince Sultan University, Saudi Arabia
c
Centre for Digital Finance, Southampton Business School, University of Southampton, UK
c
Department of Business Administration Eman Institute of Management & Sciences, Karachi, Pakistan

ARTICLE INFO ABSTRACT

Keywords: In this paper, we analyze the connectedness between the recent spread of COVID-19, oil price volatility shock,
COVID-19 the stock market, geopolitical risk and economic policy uncertainty in the US within a time-frequency frame-
Economic policy uncertainty work. The coherence wavelet method and the wavelet-based Granger causality tests applied to US recent daily
Geopolitical risk data unveil the unprecedented impact of COVID-19 and oil price shocks on the geopolitical risk levels, economic
Stock market
policy uncertainty and stock market volatility over the low frequency bands. The effect of the COVID-19 on the
Oil prices
Wavelet
geopolitical risk substantially higher than on the US economic uncertainty. The COVID-19 risk is perceived
Causality differently over the short and the long-run and may be firstly viewed as an economic crisis. Our study offers
several urgent prominent implications and endorsements for policymakers and asset managers.

1. Introduction EPU index of Baker, Bloom, and Davis (2016),1 has shown a jump going
from 100 to 4002 by 24 of March 2020.
The US economy is facing two serious shocks: the spread of the In the financial press, the COVID-19 effects are often compared with
novel COVID-19 pandemic and the recent oil price slump. The combi- the Global Financial Crisis (GFC) of 2008, which has been widely re-
nation of these two problems will likely initiate a long-term economic searched in interconnectedness, contagion and spillover effect literature
downturn and drive the US economy into the next recession. The (e.g. Kenourgios, Samitas, & Paltalidis, 2011; Dimitriou, Kenourgios, &
COVID-19 pandemic outbreak continues its tremendous spread in the Simos, 2013; Bekiros, 2014; Luchtenberg & Vu, 2015; Yarovaya,
US causing unprecedented effects of the US stock markets volatility and Brzeszczyński, & Lau, 2016, to name but a few). However, prior to the
the economic policy uncertainty where the recent stock volatility levels GFC, there were many structural problems in the US economy, while
rival or exceed those observed during October 1987, December 2008 during the COVID-19 crisis the one distinctive crisis shock is evident,
and during the 1929 crash. In a recent study, Baker et al. (2020), Baker, which is a spread of COVID-19. All other government actions and re-
Bloom, Davis, and Terry (2020) unveil that during the last 22 trading strictions are an immediate response to the pandemic channel of the
days (24 February to 24 March), 18 stock market jumps were recorded COVID-19 contagion. Thus, Harvey (2020) highlighted the differences
and 16 to 18 of them are perceived as a response to “bad news” at- between the GFC and COVID-19 crises and refers to the emerging
tributed to either the new infectious disease or the US policy responses pandemic crisis as the “Great Compression”.3 Some journalists and ex-
to the COVID-19 outbreak (Baker, Bloom, Davis, Kost, et al., 2020; perts also compare the COVID-19 crisis with global wars, responding to
Baker, Bloom, Davis, & Terry, 2020, p. 2). Similarly, during the same the dramatic news coming from China, South Korea, and recently from
period the US economic policy uncertainty as gauged by news-based Italy and Spain, unveiling that this new infectious disease is different

Corresponding author.
⁎

E-mail addresses: [email protected] (C. Aloui), [email protected] (L. Yarovaya).

1
http://www.policyuncertainty.com/us_daily.html.
2
The EPU index of Baker, Bloom et Davis was normalized to 100 from 1985 to 2010. Therefore, values exceeding 100 reflect higher than average uncertainty level.
3
Campbell Harvey “The Economic and Financial Implications of COVID-19” (3rd April, 2020), the Mayo Center for Asset Management at the University of Virginia
Darden School of Business and the Financial Management Association International virtual seminars series. https://www.darden.virginia.edu/mayo-center/events/
virtual-speaker-series.

https://doi.org/10.1016/j.irfa.2020.101496
Received 13 April 2020; Received in revised form 30 April 2020; Accepted 1 May 2020
Available online 15 May 2020
1057-5219/ © 2020 Elsevier Inc. All rights reserved.
A. Sharif, et al. International Review of Financial Analysis 70 (2020) 101496

and much more dangerous from previous outbreaks. The lockdown concern is that oil markets may recover through OPEC+ alliance ne-
measures that have been implemented by many countries affected gotiations lead by oil mega-producers or any other arrangements, while
businesses, job securities, and essential services, and some argued that uncertainty regarding the COVID-19 outbreak and its short- and long-
the analysis of financial variables in response to COVID-19 is incon- term blows remain the main concern of the US policymakers. According
clusive, and focus should be made on the physical quantities referring to Fig. 1(e) the geopolitical risk index has shown a free fall starting from
to supply and demand imbalances in the labor market.4 However, we the onset of the COVID-19 in China. The index went from 1.001 points
argue that the COVID-19 crisis falls in the category of pandemics and on January, 21st to around 105 points on the March, 27th, 2020
generates a different type of contagion to both the GFC and wars. A pointing out an unprecedented upsurge of the geopolitical risk in the
more accurate comparison can be made with similar pandemics and US. The COVID-19 seems to be the major global geopolitical shock.
epidemics events (Correia, Luck, & Verner, 2020; Eichenbaum et al., These concerns are motivating our study. It is a first endeavor to
2020; and Ma, Rogers, & Zhou, 2020), or natural disasters. analyze the connectedness and the lead-lag interplay between the
The COVID-19 pandemic is a source of systematic risk, therefore COVID-19, oil price, EPU and stock market in the US within a time-
there is a need for further research on financial effects of coronavirus frequency-based approach. To achieve this task, we resort to the wa-
spread. In this paper, we specifically focus on the US financial markets velet methods. Specifically, we implement the continuous wavelet
for several reasons. First, the US markets were one of the main sources transform (CWT) and wavelet coherence (WC) as well as the wavelet-
of a spillover effect to other markets and regions, as confirmed by based causality tests to recent US data. At least three foremost aspects
Bekaert, Ehrmann, Fratzscher, and Mehl (2011), Syriopoulos, Makram, arouse the use of the wavelets. First, the wavelet method allows us to
and Boubaker (2015), among others. Second, the spread of COVID-19 in analyze the association between the selected variables within the time-
the US has followed the crisis in China, Korea, Iran, and Italy, therefore scales and frequency bands (i.e. Investment horizons). Here, we hy-
the US authorities already had more information about the risk related pothesize that due to differences in risk profiles, heterogeneous ex-
to the COVID-19 spread and could use the other countries' experience to pectations and various perceptions of risk, US investors may react dif-
mitigate the risk. By mid-January, only a few cases were disclosed in ferently in terms of their investment decisions over investment
the United States, but their number started growing exponentially by horizons. For instance, “bad” news inherent to the US climbing COVID-
the end of March. The situation is the US turned out to be quite similar 19 infected cases, deaths, governments' distancing guidelines as well as
to Lombardi in Italy or South Korea. According to the Worldometer oil price movement shocks may be perceived differently by market
Data Tracker (WDT), the number of the US confirmed cases ex- traders. Bad news may induce short-term traders to sell, while long-run
ponentially rose to above 1.04 million, with 59,266 deaths by the 29th, traders may perceive the same news as a buying opportunity with the
April 2020. Third, the COVID-19 pandemic was not the only source of perception that such news would have a transitory bearing on the
systematic risk to the US financial markets. Global financial markets market (Chakrabarty, De, Gunasekaran, & Dubey, 2015).
also have been hit severely by oil price fall. Two months after the onset For example, the anticipation of the fiscal policy response by the US
of the COVID-19 epidemic in Wuhan city, the oil price triggered a government to support the economy in the times of COVID-19 might be
spectacular fall by around 30% (20% for the West Texas Intermediate interpreted by the investors as a positive signal, encouraging invest-
(WTI) oil), which is the largest slump since the Gulf war, after the ment in SP500 stocks since the government will help the businesses to
unexpected decision of Saudi authorities to offer price discounts of 6$ continue their operations. With the actual announcements of fiscal re-
to 8$ to their main customers in Europe, Asia, and the US. These two sponse to the COVID-19 crisis, US$ 2.3 trillion (around 11% of GDP)
serious shocks have triggered the worldwide stock markets to free fall Coronavirus Aid, Relief and Economy Security Act (“CARES Act”) in the
as a result of the oil price war and fears over the dramatic news of US,5 would be interpreted as positive news by the investors even in the
infections and patient deaths cases coming especially from Italy, France middle of the COVID-19 pandemic. Thus, investors will create a watch-
and Spain. The study by Aloui, Ben Aissa, and Nguyen (2011) found list of top stocks to prepare for the future market uptrend. Based on
that countries with higher sensitivity to commodity-price changes tend that, we hypothesize that the association between the novel COVID-19
to co-move closely with the US in both bullish and bearish markets. pandemic news, oil price volatility, US stock market and EPU will vary
Thus, by analysis of the impact of COVID-19 and oil shock on the US across time-scales and frequency bands. A key feature of wavelets
market, we can provide useful insights for the contagion and spillover pertains to their capacity to uncover latent processes with changing
effect studies in other countries and regions, contributing to this large cycle patterns, trends, lead-lag interactions and non-stationary that
and important research area. characterize these time series.
Apart from theoretical contributions, this paper will be interesting Second, wavelet methods are relevant when the interactive lead-lag
for a broad range of market participants. The investors' perception of relationship between the used time series is nonlinear. In a recent study
coronavirus risk will shape the US economic anxiety, the economic using Google research data, Fetzer, Hensel, Hermle, and Roth (2020)
policy uncertainty and the stock market behaviour. In Fig. 1, we report unveiled a rapid increase of economic anxiety during and after the in-
the time paths of the WTI benchmark crude oil price, US economic itial global spread of the Coronavirus. They report substantial non-
policy uncertainty as measured by EPU index of Baker et al. (2016), the linearity in the COVID-19 spread and an overestimation of the mortality
US-geopolitical risk as gauged by geopolitical risk (GPR) index designed and its contagiousness effects. Here, we hypothesize the nonlinear ef-
by Caldara and Iacoviello (2018) and the US COVID-19 counts as re- fect which may be also attributed to the investors' heterogeneous ex-
ported by the US Center for Disease Control and Prevention (CDC). pectations across short and long-run investment horizons. Third, the
We can observe the free fall of oil prices, as well as the exponential timeliness of data is a critical practical issue. We acknowledge that this
increase of the infected cases in the US, have substantially raised the paper is one of the first studies on COVID-19, and only a short period of
economic uncertainty and geopolitical risk levels in the US, while the data can be collected. To estimate the current and the future time-fre-
Dow Jones index drops by 2000 points in its worst day since December quency causalities between COVID-19, EPU, stock returns and oil re-
2008. searchers would need long period data to get high statistical inference
Undoubtedly, news regarding oil prices and the COVID-19 outbreak from the used tests, which makes the majority of traditional econo-
seem to be the irresistible drivers of the US stock market. The major metrics techniques not appropriate for the current study. Therefore, in

4 5
For example, Branko Milanovic commentary at Foreign Affairs https:// For all policy responses to COVID-19 see International Monetary Fund page:
www.foreignaffairs.com/articles/2020-03-19/real-pandemic-danger-social- https://www.imf.org/en/Topics/imf-and-covid19/Policy-Responses-to-COVID-
collapse. 19#U.

2
A. Sharif, et al. International Review of Financial Analysis 70 (2020) 101496

(a) WTI oil price (b) US EPU

60 700

600
50
500

400
40
300

30 200

100
20
January February March 0
January February March

(c) US COVID-19 counts (d) Dow-Jones Index

30,000
140,000

120,000 28,000

100,000
26,000
80,000
24,000
60,000
22,000
40,000

20,000 20,000

0
18,000
January February March
January February March

(e ) US-GPR index
1,200

1,000

800

600

400

200

0
January February March

Fig. 1. Time series trend of US-COVID-19 counts, US-EPU index, US-GPR index, WTI price and Dow-Jones index.

this paper, we use the wavelet method since it is not affected by the size inevitable trade-off between the severity of the short-run recession
of the data sample. caused by the pandemic and the health consequences of the COVID-19
Many scholars responded to the urgent need of research on the spread. Ma et al. (2020) compared global economic and financial effects
impact of COVID-19 pandemic on the global economy and international of COVID-19 pandemic with past epidemic and pandemic events, such
financial markets. Eichenbaum, Rebelo, and Trabandt (2020) utilized as SARS in 2017, H1N1 in 2009, and MERS in 2012, Ebola in 2014, and
the canonical epidemiology model to study the interaction between Zika in 2016, as identified by Jamison et al. (2017). Goodell (2020)
economic decisions and pandemic, highlighting the existence of an discusses the economic and social impact of COVID-19 making parallels

3
A. Sharif, et al. International Review of Financial Analysis 70 (2020) 101496

with previous crisis events. In corporate finance, Corbet, Hou, Yang, policy uncertainty and the US-geopolitical risk within time-scales and
Lucey, and Les (2020) analysed the impacts of being named “corona” frequency bands. Secondly, we deem that the GPR index is more re-
on return and volatility behaviour of stocks during the COVID-19 levant than the EPU index since the latter is more designed based on
pandemics. The results display that companies exhibit strong negative selected words related to US economic, uncertainty or others related to
hourly returns and an exceptionally large increase in hourly volatility legislation or regulation. However, the GPR index includes words re-
and trading volumes after the announcement of COVID-19 pandemic. lated to geopolitical tensions and other adverse geopolitical extreme
Flights to safety behaviour on financial markets during the COVID-19 events. Finally, using the two indexes, allows us to conduct comparative
crisis have been analysed by Conlon and McGee (2020), as well as analysis in terms of responses to the oil and COVID-19 shocks. The time
Corbet, Larkin, and Lucey (2020) in relationship to gold and crypto- period of collected data is from 21 January 2020 to 29 March 2020 and
currencies, providing consistent evidence that Bitcoin does not offer all the series are converted into natural logarithmic series.
hedging nor safe haven properties during the COVID-19 pandemic.
Furthermore, Yarovaya, Matkovskyy, and Jalan (2020) analysed 2.1. The continuous wavelet transforms (CWT)
herding in cryptocurrency markets during the COVID-19 pandemics,
reporting that herding remains contingent on up or down markets days, The continuous wavelet transforms Na (p, q) shows the projection of
but does not get stronger during the COVID-19. Yarovaya, a wavelet ψ (.) in contrast to the time sequence a (t) ∈K2(Ṟ), i.e.
Brzeszczynski, Goodell, Lucey, and Lau, (2020) discuss the unique
characteristics of the COVID-19 crisis in comparison to previous crisis 1 t p
Na (p, q) = a (t ) dt
episodes and provide directions for future research. q M (1)
The remainder of this paper is organised as follows. Section 1 dis- An essential feature of this technique is its potential to decompose
cusses the prior research in this area used to build theoretical argu- consequently and seamlessly recreate a time series a (t) ∈K2 (Ṟ):
ments of this paper. Section 2 explains the data and methodology em-
ployed in this study. Section 3 presents the empirical results, while 1 dq
a (t ) = Na (p, q) p, q (t ) du ,M>0
Section 4 concludes. C 0 M2 (2)

Moreover, this technique preserves the power of the observed time

2. Data and methodology sequence,
1 dq
The data used in this study comprises of daily observations of a 2 = |Na (p, q)|2 dp
COVID-19 (measured as a number of the infected cases of a novel
C 0 M2 (3)
COVID-19 in the US), oil prices (measured as WTI benchmark crude oil In the present paper, we count on the aforesaid flexible tactic in the
prices), US-EPU (news-based index), the US-geopolitical risk index form of the wavelet coherence, which enumerates the successiveness
(GPR) and US stock price index (SPI) as measured by the Dow Jones 30 between two time series in a bivariate model.
index. The data of COVID-19 is collected from the website of the
Centers for Disease Control and Prevention (CDC).6 Moreover, the data 2.2. The wavelet coherence (WC)
of oil and US stock market are gathered from DataStream, while the
information of EPU is sourced from the website of Economic Policy The connectedness between the COVID-19, Economic policy un-
Uncertainty. The US-GPR index is collected from Caldara and Iacoviello certainty (EPU), US stock market and crude oil prices can be analysed
(2018) database. The time period of collected data is from January, 21st through time scales by considering the widely implemented metho-
2020 to March, 30, 2020, yielding 50 observations and all the series are dology irrespective of the time series, i.e., wavelet coherence.
converted into natural logarithmic series. Practically speaking, the cross wavelet power and cross wavelet trans-
For the geopolitical risk, we refer to the updated global GPR index form (CWT) defined first. Torrence and Compo (1998), stated that the
suggested by Caldara and Iacoviello (2018).7 The GPR index is an index cross wavelet transform can be clarified by two-time sequence a (t) and
based on news related to geopolitical events. It mirrors outcomes taken b (t) as:
from automated text-search of the electronic archives which captures
eleven national and international newspapers selected by above au- Nab (p, q) = Na (p, q) Nb (p, q) (4)
thors. The number of words related to geopolitical risk are counted each where, Na (p, q) and Nb (p, q) depicts two continuous transforms of a (t)
day in each newspaper to calculate daily GPR index.8 Afterward, the and b (t), separately, p shows the location index and q is the measure,
entire index is normalized by equating the average value corresponding whereas composite conjugate is shown by (*). The cross wavelet
to the 2000–2009 decade to 100 (for details, see Caldara and Iacoviello, transform can be used to calculate wavelet power by | Na (p, q) |. The
2018). At least three foremost aspects are motivating the use of the US- cross wavelet power spectra separate the section in which strong energy
EPU and the US-GPR. First, using these indexes, we can assess the im- concentration is revealed (cumulus of the restrained variance) in the
pact of the combined COVID-19 and oil prices on the US-economic domain related to time-frequency comparatively to the time series
under consideration. The wavelet coherence technique (WCT) can as-
6
https://www.cdc.gov/coronavirus/2019-ncov/cases-updates/cases-in-us. certain the specific parts in the domain of time-frequency, where un-
html. expected and major variations happen in the co-movement patterns of
7
Source: “Geopolitical Risk (GPR) Index” by Iacoviello (2019) at https:// the time series under observation. The equation of the coefficient of
www2.bc.edu/matteo-iacoviello/gpr.htm. adjusted wavelet coherence as identified by Torrence and Webster
8
Various GPR indices are constructed by the authors by counting the words (1998) is as follows:
related to geopolitical tensions resulting from automated text searches in 11
leading national and international newspapers. The newspapers included in |M (M 1Nab (p, q)|2
W 2 (p, q) =
automated text search are Daily Telegraph, The Guardian, The Times, The M (M 1 |Na (p, q)|2 ) M (M 1 |Nb (p, q)|2 ) (5)
Washington Post, The Chicago Tribune, The Wall Street Journal, The New York 2
Times, The Financial Times, The Boston Globe, The Daily Telegraph and the where M is the smoothing mechanism. This 0 ≤ W (p, q) ≤ 1 shows the
Globe and Mail. Some of the key words used for construction of GPR index are range of squared wavelet coherence coefficient. Closeness to zero is the
“geopolitical”, “uncertainty”, “war risk”, “Middle East tension” and similar indication of the absence of correlation, while closeness to unity is the
words hinting toward some geopolitical tensions (For more details see Caldara indication of a high correlation. The method of Monte Carlo is utilized
& Iacoviello, 2018). to examine the hypothetical allocation of wavelet coherence.

4
A. Sharif, et al. International Review of Financial Analysis 70 (2020) 101496

Fig. 2. CWT plots for the stock market, the economic policy uncertainty (EPU), the geopolitical risk (GPR), Oil and the COVID-19 counts in the US.

3. Empirical results and discussion unexpected price discount by the Saudi Arabia and the subsequent
meltdown in crude oil markets which become visible through a sig-
3.1. The continuous wavelet transforms and the wavelet coherence nificant island of high volatility over the short-run (1–4 days' frequency
bands). A relatively different pattern is observed for the EPU index.
The continuous wavelet transforms (CWT) plots for each variable High EPU index volatility is noticed starting from the inception of the
are conveyed in Fig. 2. The CWT describes the movements of each sample period which may be mainly explained by the bad news related
variable in the time-scales and frequency bands. For the US, stock to the novel infectious disease upsurge and tumultuous sanitary con-
market risk is clearly apparent as a response to the announcement of the ditions in China. After that, the US EPU jumps to reach its zenith at the

5
A. Sharif, et al. International Review of Financial Analysis 70 (2020) 101496

end of the sample period (around 400 by the end of March 2020) re-
flecting an unprecedented level of EPU in the US. The CWT plot is in
line with the time path of the EPU index reported in Fig. 1. As for oil
price time-path, two islands of high volatilities for the 1 to 8 and up to
16 days-frequency bands and initiating from February can be easily
spotted in the CWT plot. The visual inspection of the US COVID-19
counts' CWT reveals small island of high volatility from the inception of
the sample period which corresponds to the first COVID-19 patient
deaths in the US. When inspecting to the US-GPR, we observe that the
CWT plot is a mixture of the CWTs of oil prices and the US-COVID-19
counts, which indicates that the unprecedented increase of the geopo-
litical risk levels in the US is driven by the combined shocks of the novel
infectious disease and the recent free fall of oil prices. Furthermore, we
identify huge island of red color corresponding to a substantial volati-
lity jumps by the end of February 2020 when the US-GPR plunges from
559 points at the beginning of the month to go under 100 points and at
the same date the oil prices dropped and the COVID-19 curve started its
exponential trend, as it was demonstrated in Fig. 1.
These results show that the US markets initially reacted to oil shock,
rather than COVID-19 news coming from Wuhan and other areas.
However, the escalating COVID-19 crisis had an immediate and pro-
found impact on the economic policy uncertainty, which confirms our
initial hypothesis that for the US economy oil remains the main source
of systematic risk, while a spread of COVID-19 increases the uncertainty
due to the unpredictable severity of the response to the pandemic.
To further analyze the interactions between selected variables,
Fig. 3 repots the wavelet coherence plots for each couple of variables.
Fig. 3a plots the wavelet coherence between the US stock index and the
US COVID-19 infected cases. We detect the existence of small islands of
strong dependence at the beginning, the mid and the end of the sample
period over the 4–8 days' frequency bands. The US market seems to
react to bad news coming from Wuhan city, December, 31st, the Chi-
nese sanitary authorities announced the first patient death and a few
days later, researchers identified the new unknown dangerous virus and
the first death was recorded on January 11. At the same time, some
infected cases were identified in South Korea, Japan and the US.
Moreover, another high coherency area is identified on mid-February
corresponding to some COVID-19 pandemic bad news such as the re-
ported first patient death in the US on February, 28th, the number of
global cases raised to 87,000 and the high-level warning announced by
the US authorities. The last substantial coherence is identified at the
end of the sample period and may be mainly due to the combined effect
of the sharp drop of oil prices and COVID-19 fears. Furthermore, arrows
are mostly turned down and left which means that there is an anti-
cyclic effect between COVID-19 and US stock index where COVID-19 is
leading. We identify a quite similar configuration in terms of islands of
strong coherencies in Fig. 3d showing the coherence between the re-
ported COVID-19 cases and the US EPU. However, we perceive that the
COVID-19 outbreak has a greater effect on the US economic un-
certainty. The red islands identified at the beginning and the end of the
sample period correspond to lower frequencies (8 to 16 days-frequency
bands) which means that it is expected to have a long-term negative Fig. 3. Wavelet coherence plots, pairwise estimates.
effect on the US economic uncertainty. The uncertainty is primarily Notes: X-axis represents the time whereas, Y-axis shows the period (in days).
related to the long-term path of the US economy and how the Federal The thick black contour represents the 5% significance level against the red
Reserve will react to the notable rise of uncertainty and bad news of the noise.
COVID-19. This is in addition to an adverse impact on the potential US
output and unemployment rate that are quite independent from the corresponding to a dramatic increase of the infected counts in the US
monetary policy. and the free fall of oil prices. The arrows are mostly turned up and to
The wavelet coherence between the US stock market and oil price the left, implying the US stock market is leading the US-EPU and the
reported in Fig. 3b reveals huge islands of red color, which indicates sharp decrease in the US market has strikingly raised the economic
strong dependency over the 4 to 8-days frequency bands for the whole policy uncertainty in the US. Fig. 3e shows the wavelet plot between oil
sample period. Unsurprisingly, the arrows are predominantly turned up and the US COVID-19 counts. We identify an island of high dependence
and to the right indicating that oil prices are leading the US market. As over the 16-days frequency band over the entire sample period and the
for the connectedness between the US stock index and EPU (Fig. 3c), arrows are mostly pointed up to the left. Other coherencies over
the WC plot reveals the existence of strong coherency islands at the 4–8 days' frequency bands can be observed with arrows turned up and
onset of the novel coronavirus and by the end of March 2020

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A. Sharif, et al. International Review of Financial Analysis 70 (2020) 101496

Table 1
Results of wavelet-based Granger causality.
Frequency domains Dependent variables Independent variables

US-stock COVID-19 EPU OIL GPR

D1 US-stock – 0.753 17.382*** 27.492*** 26.483***

COVID-19 6.583* – 19.583*** 1.584 2.525
EPU 54.934*** 1.493 – 22.491*** 13.883***
OIL 29.554*** 2.832 12.484** – 3.021
GPR 16482*** 0.583 17.095*** 19.593*** –
D2 US-stock – 0.482 18.694*** 25.483*** 25.955***
COVID-19 14.694** – 35.437*** 0.593 0.835
EPU 5.246* 0.117 – 18.658*** 15.229***
OIL 38.593*** 1.442 19.464*** – 2.925
GPR 9.531** 2.583 26.652*** 32.049*** –
D3 US-stock – 0.382 1.049 24.599*** 3.524
COVID-19 0.005 – 1.854 0.559 0.746
EPU 2.001 1.521 – 18.482*** 12.486***
OIL 19.943*** 0.547 2.005*** – 2.571
GPR 8.686** 1.689 14.635*** 27.531*** –
D4 US-stock – 0.284 1.448 16.485*** 2.069
COVID-19 0.048 – 1.553 0.491 0.562
EPU 0.795 1.592 – 16.385*** 17.694***
OIL 22.486*** 2.211 1.115 – 0.667
GPR 10.052** 2.684 3.091 20.158*** –
D5 US-stock – 2.195 4.593* 18.707*** 8.246**
COVID-19 2.372 – 0.559 1.533 0.359
EPU 5.492* 0.481 – 25.203*** 3.037
OIL 57.492*** 1.887 0.485 – 0.583
GPR 19.692*** 7.593** 2.948 16.327*** –
D6 US-stock – 2.003 1.471 94.473*** 10.537**
COVID-19 0.002 – 1.574 0.348 0.236
EPU 3.028 1.029 – 18.472*** 2.437
OIL 83.472*** 0.551 0.083 – 0.436
GPR 20.537*** 11.695** 0.368 14.215*** –
Original US-stock – 2.258 0.0837 17.676*** 23.643***
COVID-19 26.328*** – 19.493*** 1.049 1.059
EPU 0.234 2.018 – 19.482*** 7.592**
OIL 10.483** 1.382 0.449 – 2.221
GPR 8.448** 1.058 7.483** 21.936*** –

Notes: Asymptotic Chi-square values are reported. ***, ** & * significant value at 1% significant value, 5%, significant value and 10% significant value. SPI refers to
Dow-Jones stock market index while EPU designates the US economic policy uncertainty index and GPR denotes geopolitical risk.

to right suggesting a cyclic relationship between COVID-19 and oil Center of Disease Control and Prevention (CDC) but two weeks later,
where oil prices are as following. These results show that the COVID-19 the country's testing capacity increased and > 17,000 positive cases are
pandemic seems to have severe implications on oil price volatility identified during the first two weeks of march. When referring to the
through the demand side because of travel restrictions and low ex- arrows, we perceive that most of them are turned right and down which
pected output growth in China and European countries. However, it implies that the causality is going from the Coronavirus pandemic to
seems early to conceptualize the effect of the new infectious disease the US-GPR during the month of March. The tremendous spread of the
outbreak on the long-term future oil prices, it is incontestable that the COVID-19 has significantly affected the US-GPR levels. As for the de-
oil markets are facing a complicated circumstance due to the rare pendence between the oil and US-GPR (Fig. 3h), the wavelet plot is
combination of rising supply and falling demand. This may explain the extremely edifying. We identify strong areas of strong dependence at
time-frequency varying pattern of the COVID-19-oil interrelationship the inception and at the end of the sample period. At the beginning of
over the last three months. the sample period areas are covering the 4–8 days' frequency while
The oil-EPU connectedness over time-scales and frequencies is those located at the end of the period are over the 8–16 days. For the
shown in Fig. 3f, it is evident that the US economic policy uncertainty is entire period, arrows are predominantly turned up and to the left re-
strongly affected by the recent oil price. Indeed, a strong island of red vealing the oil as leader and the GPR as follower. The recent oil price
color is identified starting from the beginning of March 2020 over the war is the main driver of the US geopolitical risk and seems to harm
16-days investment horizon corresponding to the unexpected price chances of international cooperation to overcome the COVID-19 pan-
discount announced by Saudi Arabia. In addition, the arrows are mostly demic.
turned down to the left implying that there is an anti-cyclic relationship The wavelet plot between the US-EPU and geopolitical risk are
between US economic uncertainty and oil prices where economic un- presented in Fig. 3i. The dependence structure is principally observed
certainty leading to lower oil prices. Fig. 3g shows the wavelet co- over the long-run (up to 16-days investment horizons) and the arrows
herence plot between the US-COVID-19 and the GPR. The visual in- are mainly turned up and the right showing pointing out the GPR as
spection of the wavelet shows the existence of huge zones of high leading variable. The unprecedented volatility jumps in the US-geopo-
coherence located at the beginning of the sample period over two fre- litical risk due to the simultaneous effect of the COVID-19 and oil price
quency bands (4-days and from 8 to16-days), matching with the onset volatility is raising the uncertainties of the US economic policies. The
of the new infectious disease and the arrival of bad news from China. wavelet coherencies between the US stock market as measured by the
Another two islands of red color are identified at the end of February Dow Jones price index and local GPR index are conveyed in Fig. 3j. This
over the 6–8-days and up to 16-days frequency bands. Indeed, at the figure clearly shows the existence of small hot red zones over the
last day of February, only 15 infected cases were announced by the US 0–4 days frequency band (i.e. short investment horizons) strong

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A. Sharif, et al. International Review of Financial Analysis 70 (2020) 101496

dependence between the two variables. For these small zones, arrows across time-scales and investment horizons, where both cyclical and
are mostly turned up and to the right indicating that the GPR is leading anti-cyclical patterns of connectedness have been identified.
the US stock market. Over the short-run, US investors are reallocating This paper is one of the pioneer studies on the financial effects of
their portfolios' assets based on their risk assessment and their short-run the COVID-19 pandemic, and the importance of research in this area is
individual perceptions of the bad news inherent to the Coronavirus highlighted by Goodell (2020). Thus, our results provide several im-
outbreak, as the main geopolitical shock in the US. Furthermore, an- portant pieces of evidence. First, the COVID-19 outbreak has a greater
other huge hot red area is identified over the 16-days frequency band effect on the US geopolitical risk and on the US economic uncertainty.
and starts from the end of February. The arrows are mostly pointed up These results confirm that the COVID-19 pandemic itself and related
and to the left suggesting the stock market index as a leading variable regulatory response to this crisis are sources of geopolitical risk, and
and the GPR as a follower. To sum up, the stock-GPR relationship and we recommend including the geopolitical risk index in the future
causalities vary through time-scales and frequencies banks. analyses of financial effects of COVID-19 outbreak. Strong con-
nectedness at low frequencies display that COVID-19 is expected to
3.2. Robustness test, the wavelet-based Granger Causality have a long-term negative effect on the geopolitical risk levels and
economic uncertainty. The uncertainty is primarily related to the long-
To check the robustness of the CWT and WC analysis outcomes, we term path of the US economy and how the Federal Reserve will react
implement the wavelet-based Granger Causality tests. The causality to the pandemic. Second, the oil slump had the strongest impact on the
tests are implemented for six frequency domains (D1 to D6), and the US stock markets in comparison to both COVID-19, EPU and GPR. We
results are conveyed in Table 1. From these results, we notice that found that oil prices were leading the US market at both low and high
unsurprisingly oil price volatility is causing the US stock index for all frequencies throughout the observation period. Third, the results show
the selected frequencies. This result is in line with previous studies that the COVID-19 pandemic also affect the oil prices, which can be
showing the substantial sensitivity of the US market to oil volatility explained by imposed travel restrictions. The robustness test esti-
shocks (see, among recent studies, Torun, Chang, & Chou, 2020 and mated the wavelet-based causality in six frequency bands, suggest the
Wu, Xu, & Yang, 2020). The effect of the EPU on the US stock market is short-term causality of COVID-19 pandemic and both the US stock and
evidenced over very short-run investment horizons (D1 to D2). Fur- the EPU, for COVID-19 - oil causality is significant at all frequencies
thermore, the wavelet-based causality is running from the COVID-19 analysed.
pandemic to the US stock market and the EPU for only the D1 and D2 Our findings offer fresh and prominent policy and practical im-
frequency domains. It is worthily noting that the COVID-19 is not plications. It is becoming clear that the COVID-19 pandemic is causing
causing the US-GPR risk levels over all the selected frequency bands, outcome disruption, an exceptional increase in the US economic policy
while it affects the US-EPU over only the D1 and D2 time-horizons. This uncertainty and unprecedented response of the stock market. While the
result may be due to the US investors who perceive the COVID-19 oil volatility shocks may be sensed as a transitory risk that could be
outbreak firstly as an economic crisis rather that reverse geopolitical depressed through the OPEC+ deals, the COVID-19 crisis can further
event. No significant effect of the COVID-19 is detected on the oil price affect oil price due to the travel restrictions around the world during the
volatility over the remaining frequency domains since the two exo- pandemic. This result is important not only for oil exploration and
genous shocks are independent. production companies, but for companies in transportation and hospi-
As for the EPU, causality is strongly influencing the oil price for all tality industries, as well as investors who have allocations in the stocks
the selected frequencies, while its effect on the US market is observed sensitive to the oil price and commodity derivatives. The US investors'
over the short-term investment horizons (D1 to D2). The EPU is sub- perceived risk inherent to the tumultuous spread of the COVID-19 as a
stantively causing the GPR levels in the US, which means that un- systematic risk shaking the US stock market raising the economic policy
certainty related to US economic conditions are mainly causing the uncertainty indexes to enormous levels. This result is consistent with a
increase of the GPR levels. When looking to the oil effect, we found a recent survey study outcome of the World Economic Forum (March
significant effect on the US market and reveals a bidirectional causal 2020).9 Therefore, the US government must avoid creating additional
linkage over all the selected frequency bands. For the EPU, the oil uncertainty by designing a coherent COVID-19 economic strategy that
impact is shown over only short-run investment horizons (D1 to D2). fosters opening the markets. From an asset management perspective,
Finally, the wavelet causality tests show that the GPR is causing the US our results show the strong short-term impact of COVID-19 on the US
stock market, the oil prices as well as the economic policy uncertainty stock markets, however, we cannot exclude the possibility that in-
across all the selected frequency bands (D1-D6). The bi-directional vestors might still expect that with the further government interven-
causalities between these variables are identified over the short-term tions, the US stock markets will be able to recover in the long-term. In
investment horizons (D1-D2). the meantime, while the COVID-19 pandemic is still ongoing, asset
managers and individual investors should know how to handle stock
4. Conclusion, some policy implications and future research market volatility and systematic risk associated with COVID-19 spread.
The used risk management framework should be reassessed to address
The economic and social costs of the COVID-19 pandemics concern the new and enhanced risks caused by the upsurge of the COVID-19
the society, policy makers, and all financial markets participants and pandemic.
individual investors. In this study, we analyze the time-frequency We would like to acknowledge, that our findings should be taken
connectedness between the recent COVID-19 outbreak, crude oil price with caution given the small size of the sample and the statistical in-
volatility shock, the economic policy uncertainty, the geopolitical risk ference from the used tests, but they pave the way for many research
and the stock market in the US using the continuous wavelet transform, questions regarding the short and long-run effects of the COVID-19
the wavelet coherence and the wavelet-based Granger causality tests. pandemic on the US output, financial stability, monetary policy and
The wavelet-based approach allows us to analyze the interactive lead- other macroeconomic factors using large data sample or even real-time
lag interactions in the time frequency domain and to overcome some data.
practical challenges inherent to the short sample period as well as other
stylized facts including stationarity and non-linearity. Using recent
daily data for the US, our wavelet analysis unveils an unprecedented
sensitivity of the US stock market, the US economic policy uncertainty
and the US geopolitical risk to the combined shocks of the COVID-19 9
https://www.weforum.org/agenda/2020/03/covid-19-public-perception-
and oil volatility shocks. The associations between the variables vary economic-health-crisis-coronavirus-pandemic-ipsos/.

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A. Sharif, et al. International Review of Financial Analysis 70 (2020) 101496

Author statement Dimitriou, D., Kenourgios, D., & Simos, T. (2013). Global financial crisis and emerging
stock market contagion: A multivariate FIAPARCH–DCC approach. International
Review of Financial Analysis, 30, 46–56.
Arshian Sharif: Data curation; Methodology; Formal analysis; Eichenbaum, M. S., Rebelo, S., & Trabandt, M. (2020). The macroeconomics of epidemics.
Investigation; Writing - original draft. 26882. National Bureau of Economic Research.
Chaker Aloui: Data curation; Investigation; Methodology; Writing - Fetzer, T., Hensel, L., Hermle, J., & Roth, C. (2020). Coronavirus perceptions and economic
anxiety. arXiv preprint arXiv:2003.03848.
review & editing; Supervision; Validation; Visualization; Project ad- Goodell, J. W. (2020). COVID-19 and finance: Agendas for future research. Finance
ministration. Research Letters. https://doi.org/10.1016/j.frl.2020.101512.
Larisa Yarovaya: Conceptualization; Investigation; Writing - original Harvey, A. C. (2020). The economic and financial implications of COVID-19 (3rd April,
2020). the Mayo Center for Asset Management at the University of Virginia Darden
draft; Writing - review & editing. School of Business and the Financial Management Association International virtual
seminars serieshttps://www.darden.virginia.edu/mayo-center/events/virtual-
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