Abstract
The systemic risk induced by a connection among financial objects is generally measured by returns, volatility, interbank loans, etc. Nevertheless, these measures do not capture the microscale component of the interconnections induced by heterogeneous investor activity. In this paper, we exploit the information in the connectedness among heterogeneous investors to develop an alternative systemic risk measure. The interconnections embed the systemic risk induced by heterogeneous investors' trading activity because investor strategies incorporate information into stock prices in terms of market stability and information spillover in the network through the information-sharing process among different investor groups. We test whether systemic risk stems from heterogeneous investors' activity. We find that the retail investors with positive net information flows, which are defined as the source in an information network, engage in destabilization regardless of their market status, suggesting that retail investors could significantly contribute to market instability. The connectedness among investors disentangles the financial crisis period from the normal market states, quantifies the systemic risk associated with too interconnected to fail, and plays a detrimental role in financial stability. We find that the portfolio set constructed based on the systemic risk using the heterogeneous investor activity has a negative relationship with the expected returns. Our findings suggest that the connectedness among investor groups has a significant impact on systematic risk and would be crucial for regulations and policymaking.
Published Version
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