Centre for Finance, Credit and Macroeconomics (CFCM)

CFCM 16/05: Business-Linkage Volatility Spillover between US Industries

Business-Linkage Volatility Spillover between US Industries


This paper examines the volatility spillovers between US industries and their dependence on the inter-industry business linkages. Our first-stage multivariate model reveals significant volatility transmission between trading industries. Our second-stage results demonstrate that inter-industry spillovers are influenced by the strength of the trading relationship. When industries are more important to their partners, as measured by the shares of inputs or revenue, they tend to have stronger volatility spillovers toward their partners and are less affected by the volatility of their partners. Qualitatively similar results are obtained regardless of the business-linkages measures used and from samples restricted to closely-linked or to non-financial industries. Importantly, business linkages are highly relevant for shock spillovers in bad market conditions. The link between volatility spillovers and the strength of the business relationship is confirmed at portfolio level as well.

In this paper, Linh Xuan Diep Nguyen and her co-authors find that return volatility spillovers are determined by trade linkages between industries. The findings have important implications for business managers, investors and policymakers. Asset managers and investors attempting to maintain portfolios focusing on a group of related companies or on specific industries are advised to take into account the spillovers between closely-linked industries in their portfolio construction. Since these portfolios may have significant weights in industries with strong commercial relationship, they are less diversified and more exposed to idiosyncratic risks.

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Linh Xuan Diep Nguyen, Simona Mateut and Thanaset Chevapatrakul


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Posted on Monday 21st November 2016

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