Inter-industry network and credit risk

Abstract

As previous literature has documented cross-industry returns and tail risk predictability, especially during a financial crisis, this research investigates the effects of industries' position within an economy, inter-industry connectedness, and industry returns on credit risk using a reduced-form approach. We employ an aggregate measure of tail risk emitted from an industry to capture its outgoing connectedness with other industries, and our empirical results show that the outgoing connectedness of some highly central industries positively impacts all sample firms’ default probabilities, controlling for a variety of firm-specific and macroeconomic variables that are well-known to be related to corporate defaults. In sum, our empirical results support that industry network risk helps explain corporate default and improves default prediction accuracy.