COVID-19 pandemic and financial innovations

Abstract

This study is motivated around the COVID-19 pandemic as a source of rising financial market risks. Hence, we investigate whether pandemic-induced risks can be hedged by alternative investment in financial innovations captured in exchange traded funds (ETFs). We explore the hedging effectiveness of sectoral ETFs along with a battery of robustness measures. Following the predictability analyses, we find that financial innovations captured in ETFs can effectively hedge both pandemic-induced and financially engineered market risks especially after controlling for the role of oil price in the predictive model. Our model provides better in-sample and out-of-sample forecasting accuracy and economic gains than the benchmark model and this is more pronounced for the COVID-19 pandemic period.