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How Networks Impact Stock Returns

Paper Session

Saturday, Jan. 5, 2019 8:00 AM - 10:00 AM

Hilton Atlanta, 212-213-214
Hosted By: American Finance Association
  • Chair: Ron Kaniel, University of Rochester

Trade Networks and Asset Prices: Evidence from the SCDS Market

Huancheng Du
,
International Monetary Fund
Dong Lou
,
London School of Economics and CEPR
Christopher Polk
,
London School of Economics and CEPR
Jinfan Zhang
,
Chinese University of Hong Kong-Shenzhen

Abstract

We exploit the information in sovereign credit default swap (SCDS) prices and the international trade network to reveal novel facts about the propagation of shocks in the global macroeconomy. We show that country fundamentals depend on both direct and indirect links in the trade network. Recognizing these links reveals novel variation in average return for the cross-section of country-level equity and credit, which we argue reflects an underreaction phenomenon occurring on a global scale. Specifically, a portfolio that goes long SCDS with the largest increase in export destinations’ credit risk and sells short SCDS with the largest decrease generates an average return of nearly 6% per year with a Sharpe ratio of 1.1. This transmission of value-relevant information across countries is even slower for indirect trade links. We exploit a natural experiment to confirm causality and a variance decomposition exercise to link a significant proportion of global volatility to the trade network.

Production Networks and Stock Returns: The Role of Vertical Creative Destruction

Michael Gofman
,
University of Rochester
Gill Segal
,
University of North Carolina
Youchang Wu
,
University of Oregon

Abstract

We study the relation between firms' risk and their upstreamness in a production network. Empirically, firms' average stock returns and productivity exposures increase monotonically with their upstreamness. We quantitatively explain these novel facts using a multi-layer general equilibrium model. These patterns
arise from vertical creative destruction -- innovations by suppliers devalue customers' assets-in-place. We conrm several model predictions, and document additional new facts consistent with vertical creative destruction: a diminished value premium among downstream firms and a negative relation between downstream
firms' returns and their suppliers' competitiveness. Overall, vertical creative destruction has a sizable effect on cross-sectional risk premia.

Return Predictability in Firms with Complex Ownership Network

Ran Zhang
,
University of Edinburgh
Angelica Gonzalez
,
University of Edinburgh
Jun Tu
,
Singapore Management University

Abstract

In this study, using data from 23 developed markets, we examine all four possible cases of stock return predictability in ownership-linked firms (OLFs): parent-subsidiary, subsidiary-parent, subsidiary-subsidiary, and parent-parent. We find that the returns of OLFs predict returns of the focal firm for all four cases. In particular, a simple long/short portfolio strategy for firms sorted by the lagged monthly returns of OLFs yields the Fama and French (2018) value-weighted six- factor alpha of up to 113 bps per month. The underreaction of focal firms to OLF returns is best explained by active internal capital markets – a specific mechanism unique to OLFs.
Discussant(s)
Robert Ready
,
University of Oregon
Stefano Giglio
,
Yale University
Lauren Cohen
,
Harvard Business School
JEL Classifications
  • G1 - General Financial Markets