Exploring the influence of Silicon Valley Bank default and U.S. financial stress on sectoral interactions and effective hedging strategies

Abstract

ABSTRACT The SVB implosion could trigger a domino effect, shaking confidence in U.S. banks. This research estimates the response of good and bad cumulative abnormal returns (G-CARs, B-CARs) on the event day, pre-event and post-event periods, using financial stress, oil, geopolitical and equity uncertainty as controls. We also examine the moderating impact of the SVB implosion and U.S. financial stress indices (US-FSI) on the good and bad dynamic conditional correlations between 132 U.S. sectoral pairings. Additionally, we assess the best portfolio distribution to determine if short positions in specific U.S. sectors offer better protection against SVB’s long-term volatility using the DCC-GARCH-t copulas. Overall findings suggest that B-CARs are more adversely affected than G-CARs. Therefore, investors need to consider bearish and bullish market conditions before devising hedging strategies. The Financials, Health Care, Industrial, Materials, Oil and Gas, Real Estate and Transportation sectors of U.S. experienced significant losses due to higher B-CARs around the SVB default event. Furthermore, the SVB default’s moderating impact on the U.S. sectoral stock returns is more pronounced during bearish market conditions compared to bullish ones following a Black Swan event. This suggests a differential moderating impact of SVB on good and bad conditional connectedness and a reduction in diversification benefits.