Title: The impact of network connectivity on factorexposures, asset pricing and portfolio diversication
Authors: Loriana Pelizzon - Goethe University (Germany) [presenting]
Massimiliano Caporin - University of Padova (Italy)
Roberto Panzica - Goethe University House of finance (Italy)
Monica Billio - University of Venice (Italy)
Abstract: The classic factor-based asset pricing model is extended by including network linkages in linear factor models. We assume that the network linkages are exogenously provided. This extension of the model allows a better understanding of the causes of systematic risk. More specifically we show that (i) network exposures act as an inflating factor for systematic exposure to common factors; (ii) the power of diversification is reduced by the presence of network connections. Moreover, empirically, in the presence of network links a misspecified traditional linear factor model presents residuals thatare correlated and heteroskedastic. We support our claims with an extensive simulation experiment.