Financial contagion risk and the stochastic discount factor
Louis R. Piccotti
Journal of Banking & Finance, 2017, vol. 77, issue C, 230-248
I provide evidence that financial contagion risk is an important source of the equity risk premium. Banks’ contributions to aggregate financial contagion are estimated in a state space framework and linked to systemic risk. Greater bank connectedness today leads to increased systemic risk 3–12 months later. More contagious banks earn significantly greater risk-adjusted returns than less contagious ones and the tradable high contagion-minus-low contagion bank portfolio is priced in the cross-section of stock returns. Stocks that co-move more strongly with contagious banks have greater expected returns. These results are robust to factor model specification, test assets, and time period considered.
Keywords: Asset pricing; Equity risk premium; Financial contagion; State-space modeling; Systemic risk (search for similar items in EconPapers)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:77:y:2017:i:c:p:230-248
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