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The more connected, the better? Impact of connectedness on volatility and price discovery in the Korean financial sector

DeokJong Jeong and Sunyoung Park

Managerial Finance, 2018, vol. 44, issue 1, 46-73

Abstract: Purpose - The purpose of this paper is to empirically analyze the effect of the increasing connectedness among financial institutions in the Korean financial market, as it affects the market microstructure in the stock market. Thus this work, first, analyzes the trend and characteristics of connectedness in the Korean financial sector. This work then demonstrates the impacts of connectedness on volatility and price discovery in the stock market. Design/methodology/approach - The entire Korean financial sector is analyzed from January 1990 to July 2015, including the periods of the 1997 Asian crisis and the 2007/2008 global financial crisis. This paper quantifies the connectedness between financial institutions using network methodology. Densely connectedness specifically refers to the cases in which a node experiences strong-lagged return spillover from and/or to itself. Findings - Connectedness is established as an important determinant of stock price discovery. This paper illustrates that connectedness increases on significant economic events such as the 1997 Asian crisis and the 2007/2008 global financial crisis. Furthermore, this paper demonstrates that the more densely connected a particular financial institution, the more volatile the stock price and the less accurate the stock price quality. Research limitations/implications - Understanding the financial system from a network perspective has been on the rise after the 2007/2008 global financial crisis. This work helps regulators and policy makers understand the full implications of introducing new policies that can more closely connect financial institutions. Originality/value - This paper precisely captures financial institutions’ connectedness by including all types of financial institutions at the micro level. Additionally, this paper links connectedness to market microstructure in the stock market.

Keywords: Price discovery; Volatility; Financial institutions; Connectedness; Korean financial sector; To connected to fail (search for similar items in EconPapers)
Date: 2018
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