Financial Sector Volatility Connectedness and Equity Returns

Mert Demirer, Umut Gokcen and Kamil Yilmaz ()
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Mert Demirer: MIT
Umut Gokcen: Koc University

Koç University-TUSIAD Economic Research Forum Working Papers from Koc University-TUSIAD Economic Research Forum

Abstract: We apply the Diebold and Yilmaz (2014) methodology to daily stock prices of the largest 40 U.S. financial institutions to construct a volatility connectedness index. We then estimate the contemporaneous return sensitivity of every non-financial U.S. company to this index. We find that there is a large statistically significant difference between the returns of firms with positive and negative exposures to financial connectedness. The four-factor alpha of a strategy that goes long in the bottom decile and short in the top decile of stocks sorted on their connectedness betas is roughly 15% per annum. Bivariate portfolio tests reveal that abnormal returns are robust to market beta, size, book-to-market ratio, momentum, debt, illiquidity, and idiosyncratic volatility. Abnormal returns are asymmetric; they are primarily driven by firms whose returns covary negatively with the index. These firms tend to be young and small, with poor past performance and low credit quality.

Keywords: Cross-section of returns; Anomalies; Financial connectedness; Vector autoregressions. (search for similar items in EconPapers)
JEL-codes: C32 G12 G21 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2018-01
New Economics Papers: this item is included in nep-cfn and nep-fmk
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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