Ambiguity in a Pandemic Recession, Asset Prices, and Lockdown Policy

Using an asset pricing model of a multi-sector production economy with pandemic disasters, we explain the average stock price boom and significant cross-sectional variation of stock returns in the US and Japan during the COVID-19 pandemic recession. Two features of the pandemic, ambiguity and sector-specific shocks, are crucial determinants of the unusual asset price dynamics. Extending the model, we analyze the welfare effects of lockdown policies during pandemics for heterogeneous households and obtain the following results. Enforcing a lockdown improves the welfare of the asset-holders and the household working in the sector with positive sector-specific shocks. A Pareto optimal lockdown policy controls the tightness of the lockdown so as to maximize the welfare of the household working in the sector with negative sector- specific shocks