Dynamic Network Risk

TL;DR

This paper investigates how dynamic network risk affects stock returns, showing stocks with higher sensitivities to this risk tend to have lower expected returns, supported by economic theory involving stochastic discount factors.

Contribution

It introduces a novel analysis of dynamic network risk in stock return pricing and links it to economic theory via the stochastic discount factor and precautionary savings.

Findings

Stocks with high network risk sensitivities earn lower returns.

A one-standard deviation increase in network risk loadings reduces expected returns by over 6%.

Long-term network risk has a slightly larger impact than short-term risk.

Abstract

This paper examines the pricing of short-term and long-term dynamic network risk in the cross-section of stock returns. Stocks with high sensitivities to dynamic network risk earn lower returns. We rationalize our finding with economic theory that allows the stochastic discount factor to load on network risk through the precautionary savings channel. A one-standard deviation increase in long-term (short-term) network risk loadings associate with a 7.66% (6.71%) drop in annualized expected returns.