A Liquidity-Based Stock Network

36 Pages Posted: 23 Nov 2016 Last revised: 30 Jan 2017

See all articles by Zhenyu Gao

Zhenyu Gao

Princeton University - Department of Economics

Wenxi Jiang

CUHK Business School, The Chinese University of Hong Kong

Da Tian

University of Florida

Date Written: November 23, 2016

Abstract

Stocks are connected through common ownership of financial institutions. Firm shocks can be transmitted and amplified through these interconnections, aggregating into market level fluctuations. We formalize this intuition by estimating a parsimonious model using mutual fund holding data. The model allows us to quantify the aggregate outcome of propagation of firm level shocks through the network. Using earnings surprises as a proxy for firm shocks, we find that our model's aggregation is significantly correlated with the aggregate market return. Also, the network structure estimated by our model can predict subsequent volatility of aggregate market returns and forecast the volatility of and correlation between individual stocks' future returns.

Keywords: network, systemic risk, amplification mechanism, liquidity shock, mutual fund

Suggested Citation

Gao, Zhenyu and Jiang, Wenxi and Tian, Da, A Liquidity-Based Stock Network (November 23, 2016). Available at SSRN: https://ssrn.com/abstract=2874699 or http://dx.doi.org/10.2139/ssrn.2874699

Zhenyu Gao

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States

Wenxi Jiang (Contact Author)

CUHK Business School, The Chinese University of Hong Kong ( email )

Room 1250, Cheng Yu Tung Building
Chinese University of Hong Kong
Shatin, NT 06520
Hong Kong

Da Tian

University of Florida ( email )

PO Box 117165, 201 Stuzin Hall
Gainesville, FL 32610-0496
United States

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