Dynamic Networks and Asset Pricing
The University of Chicago; Imperial College Business School; Centre for Economic Policy Research (CEPR)
IE Business School
December 21, 2012
AFA 2013 San Diego Meetings Paper
In the context of an equilibrium model with multiple risky assets, we map the characteristics of the network connecting firms' fundamentals to the cross-section of expected returns. We interpret network connectivity as the ability to transfer a distress state to other firms' fundamentals in a directed and timely manner. We show that 'central' firms, active at transferring but relative immune to distress, have lower P/D ratios and higher expected returns. We use corporate earnings to take the model to the data and estimate the network structure. In accordance with theoretical predictions, we find evidence of a positive centrality price of risk and a sizable centrality risk premium. Furthermore, network centrality helps to motivate the value premium as a distress causality risk premium: part of the expected return of value stocks in excess of growth stocks is a centrality premium in our results, and value stocks severely under-perform during economic downturns.
Number of Pages in PDF File: 33
Keywords: Dynamic Networks, Cross-Section of Expected Returns, Lucas Orchard
JEL Classification: G12, G14
Date posted: March 19, 2012 ; Last revised: December 23, 2012
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