mentioned above, we expect stock prices to fall more for levered oil firms in response to the 2020 oil crash.

To test whether debt levels mediate the effect of oil price fluctuations on stock returns, we use daily data on oil prices and stock prices of U.S. oil firms from January to June 2020—a period of great upheaval for the oil market. Taking the issue of endogeneity seriously, we establish a causal relationship between changes in oil prices and changes in stock prices of oil firms by following a heteroskedasticity identification strategy developed by Rigobon (2003).<sup>9</sup> Specifically, we instrument for changes in oil prices with plausibly exogenous news that might exclusively affect current or future oil supplies, coined “oilspecific news.” We note that current oil demand by investors may increase if oil-specific news makes them worry about the availability of future oil supplies. We call days with oil-specific news “event days” and days without oil-specific news “non-event days.” The results are twofold. First, a decline in oil prices statistically significantly reduces oil stock returns. A 1 percent decline in oil prices leads on average to a 0.44 percent decline in stock prices. Furthermore, the elasticity becomes smaller with lower oil prices. Second, our empirical results point to the “irrelevance” of debt in mediating the effect of oil prices on oil stock returns. The role of total debt becomes smaller and statistically insignificant after standard firm characteristics are progressively controlled for. The liquidity backstop provided by the Federal Reserve appears not to have muted the role of debt for oil firms.

This paper contributes to the rapidly growing strand of the finance literature exploring the effect of COVID-19 on firm performance. Notably, Ding et al. (2021) evaluate the connection between corporate characteristics and the reaction of stock returns to COVID-19 cases for firms across over 60 economies. The authors find that the pandemic-induced drop in stock returns was milder among firms with stronger pre-2020 finances and less exposure to COVID-19 through global supply chains. Fahlenbrach et al. (2020) document that firms with high financial flexibility within an industry experience a stock price drop of 26 percent, or 9.7 percentage points, lower than those with low financial flexibility. This differential return persists as stock prices rebound. The authors also argue that their findings cannot only be explained by the leverage effect. On the more normative front, Brunnermeier and Krishnamurthy (2020) develop a corporate finance framework to guide interventions in credit markets to avoid scarring. The authors emphasize that policies reducing funding costs are only socially desirable if the pandemic is expected to be short-lived and if bankruptcy costs are high. Our paper contributes to this strand of literature by documenting the absence of the role of corporate debt in mediating the effect of the COVID- 19 induced oil price crash on stock returns for oil firms. We also explore the role of the Federal Reserve liquidity provision in explaining our results on the muted role of debt.

Our paper also contributes to the strand of literature on the nexus between corporate debt and oil firms. Donders et al. (2018) document that between 2003 and 2015, a 10 percent change in oil price leads to a 0.15 percent change in the bond yields of oil firms. Also, Gilje et al. (2020) show that highly indebted oil firms are forced to make distorted investment decisions.<sup>10</sup> They complete projects early to enhance collateral value at the expense of long-run project return. Our findings suggest that the role of debt in the transmission of oil price fluctuations to stock prices is not robust to controlling for other firm characteristics.

> 9 See studies employing the heteroskedasticity identification strategy in different applications: Rigobon and Sack (2004), Anderson et al. (2007), Ehrmann et al. (2011), Chaboud et al. (2014), Hébert and Schreger (2017).

> 10 Domanski et al. (2015) highlight the high debt burden of the oil sector during the collapse of oil price in 2014.

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