The Spread Of The Credit Crisis: View From A Stock Correlation Network

H/T Pablo for sending this in, thank you very much.

Click Here To Read: The Spread Of The Credit Crisis: View From A Stock Correlation Network

Abstract (Via Reginald Smith)

The credit crisis roiling the world’s financial markets will likely take years and entire careers to fully understand and analyze. A short empirical investigation of the current trends, however, demonstrates that the losses in certain markets, in this case the US equity markets, follow a cascade or epidemic flow like model along the correlations of various stocks. This phenomenon will be shown by the graphical display of stock returns across the network as well as the dependence of stock returns on topological measures. Finally, whether the idea of “epidemic” or a “cascade” is a metaphor or model for this crisis will be discussed.

Excerpts (Via Reginald Smith)

Though the hardest hit markets are lesser-known markets, such as commercial paper, the equity markets have become the most widely known indicators of the ongoing meltdown. In fact, most non-experts likely use the movements of the equity markets, fallaciously, as a key gauge of the severity or progress of the crisis. The equity markets, however, did not originate the crisis nor are they the key force perpetuating it. In this short paper, the spread of the credit crisis will be discussed by referring to a correlation network of stocks in the S&P 500 and the NASDAQ-100 indices. The fact that the spread resembles a contagion or cascade, however, may be mainly superficial given the underlying dynamics are completely different.

The spread is carried both by the news of the extent of the crisis and the fact that similar risky asset bases make the co-movement of certain stocks more likely and thus more highly correlated. In addition, as credit becomes restricted, capital flows formerly relied on as a given begin to disappear, causing financial difficulties in companies and selling of equities (among other assets) to raise capital. As panic and the extent of the devastation spread, stocks are punished accordingly. In normal times, the failure of a company and its stock is not a cause for a systemic crisis…..

Click Here To Read: The Spread Of The Credit Crisis: View From A Stock Correlation Network