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Dynamic Networks and Asset Pricing

33 Pages Posted: 19 Mar 2012 Last revised: 23 Dec 2012

Andrea Buraschi

The University of Chicago; Imperial College Business School; Centre for Economic Policy Research (CEPR)

Paolo Porchia

IE Business School

Date Written: December 21, 2012

Abstract

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.

Keywords: Dynamic Networks, Cross-Section of Expected Returns, Lucas Orchard

JEL Classification: G12, G14

Suggested Citation

Buraschi, Andrea and Porchia, Paolo, Dynamic Networks and Asset Pricing (December 21, 2012). AFA 2013 San Diego Meetings Paper. Available at SSRN: https://ssrn.com/abstract=2024483 or http://dx.doi.org/10.2139/ssrn.2024483

Andrea Buraschi

The University of Chicago ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
7738347123 (Phone)

HOME PAGE: http://www.andreaburaschi.com/

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

HOME PAGE: http://www.andreaburaschi.com/

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Paolo Porchia (Contact Author)

IE Business School ( email )

Serrano 99
Madrid, 28006
Spain
+34917821706 (Phone)
+34 91 745 47 62 (Fax)

HOME PAGE: http://paolo-porchia.profesores.ie.edu/

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