Unveiling True Connectedness in US State-Level Stock Markets: The Role of Common Factors
This paper examines US state-level market spillovers using Lasso regularization and common factor filtering to ensure accurate interconnectedness.
What it examines
This study investigates the connectedness among US state-level stock markets by estimating spillover indexes of returns and volatilities using common factor filtering and Lasso regularization. It aims to provide accurate risk assessment by eliminating overestimated interdependencies that can mislead investors and policymakers.
What it concludes
The study shows that filtering common factors and using Lasso regularization yields more realistic spillover indexes, aiding accurate risk assessment. These refined models help investors manage portfolios and enable policymakers to set effective regulations. Future research may explore spillovers in other asset classes.
Evidence objects
Caporin, Cepni, and Gupta find that ignoring common factorsmarket returns, size, value, momentum, profitsin US state-level stocks exaggerates interconnectedness, overestimating risk spillovers and misleading investors regarding contagion and allocation prospects.
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By filtering out common factors before applying Lasso-regularized VAR, researchers effectively analyze three decades of stock data using a dynamic rolling-window method, fundamentally redefining systematic risk measurement and portfolio strategies.
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Though the novel approach improves model precision, it struggles with abrupt market shifts and complex high-frequency data, prompting further research to refine methods and align theoretical assumptions with financial uncertainties.
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This paper explores US statelevel stock returns and volatility interconnectedness using an innovative methodology that prefilters common factors and employs Lasso regularization within $\text{VAR}$ models. Its approach skillfully avoids spillover overestimation, offering fresh, compelling insights and a unique, original perspective that enriches equity market research. Ultimately advancing financial market understanding.
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Raw abstract and provenance
- The objective of this paper is to analyze the time-varying degree of interconnectedness of 50 statelevel stock returns and their volatility of the United States (US) while …
Source row: 2108 · abstract type: snippet