Dynamic interactions of actual stock returns with forecasted stock returns and investors’ risk aversion: empirical evidence interplaying the impact of Covid-19 pandemic

Adnan Abo Al Haija () and Rahma Lahyani ()
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Adnan Abo Al Haija: Alfaisal University
Rahma Lahyani: Alfaisal University

Review of Quantitative Finance and Accounting, 2023, vol. 61, issue 3, No 11, 1129-1149

Abstract: Abstract In this paper, we examine the dynamic relationship between actual stock returns, forecasted returns and investor risk aversion, where variables are analyzed in first difference form rather than levels. The idea behind using such methodology is to find out how variables move together contemporaneously, and to explain how changes in actual stock returns adjust to contemporary forecasted returns and changes in risk aversion, considering the interplaying effect of the Covid-19 pandemic. We use daily US stock market data, for five consecutive years ranging from 2018 to 2022. Empirical analysis shows that, ceteris paribus, (i) actual returns adjust swiftly to forecasted returns and (ii) the adjustment coefficient increases significantly during the pandemic, implying that investors become more sensitive to the implicit information in the formulated forecasts. In addition, it has been found that an increase in daily risk aversion leads to a simultaneous decline in actual stock returns. Although the risk aversion index reached high levels during the pandemic, its marginal effect on the dynamics of returns has diminished during this period, suggesting that investors with high levels of risk aversion become less sensitive to the ongoing crisis. Other factors, such as market volatility and trade intensity, have almost negligible effects on the dynamics of daily returns.

Keywords: Forecasted stock returns; Risk aversion; Dynamic changes; Covid-19 pandemic (search for similar items in EconPapers)
JEL-codes: F31 G12 G15 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1007/s11156-023-01181-0

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