Implications of Stochastic Transmission Rates for Managing Pandemic Risks

Abstract

We develop a model of pandemic risk management and firm valuation. We introduce aggregate transmission shocks into an epidemic model and link valuations to infections by using an asset-pricing framework that accounts for vaccines. Infections lower earnings growth but firms can mitigate damages. We estimate a large reproduction number R_0 and transmission volatility for COVID-19. Using these estimates, we assess the accuracy of deterministic approximations based on R_0. Our model generates predictions consistent with data: unexpected infection resurgence, non-monotonic mitigation policies and higher price-to-earnings ratios during a pandemic. Stock market values would be significantly lower absent mitigation and a high vaccine arrival rate.

Keywords: COVID-19, stochastic epidemic model, risk management, stock valuation

JEL Classification: G12, I10, G31, E30