Text-Based Linkages and Local Risk Spillovers in the Equity Market

Abstract

This paper uses extensive text data to construct firms' links via which local shocks transmit. Using the novel text-based linkages, I estimate a heterogeneous spatial-temporal model which accommodates the contemporaneous and dynamic spillover effects at the same time. I document a considerable degree of local risk spillovers in the market plus sector hierarchical factor model residuals of S&P 500 stocks. The method is found to outperform various previously studied methods in terms of out-of-sample fit. Network analysis of the spatial-temporal model identifies the major systemic risk contributors and receivers, which are of particular interest to microprudential policies. From a macroprudential perspective, a rolling-window analysis reveals that the strength of local risk spillovers increases during periods of crisis, when, on the other hand, the market factor loses its importance.