The impact of the global financial crisis on firm‐level risk of the S&P 500

Abstract

PurposeThis paper aims to assess the impact of the global financial crisis of 2007‐09 on the risk structure of S&P 500 firms by examining their market, active, and residual risks before and during the crisis.Design/methodology/approachThe classic one‐factor model is estimated for each firm in the S&P 500 to decompose risk into market, active, and residual components. Five sets of regression estimates based on monthly return data are used: 2002‐06, 2003‐07, 2004‐08, 2005‐09, and 2006‐10. The estimates provide insight into the risk structure of S&P 500 firms before and during the crisis.FindingsThe average correlation coefficient between S&P 500 firms rose during the crisis from 0.20 to 0.35, an increase of 75 percent. Although the results indicate that active and residual risks are significant across the firms and across the periods, the impact of the financial crisis was mostly on market risk. The increase in risks was pronounced for financial firms, especially insurance companies, and industrial firms, especially “hard” manufacturing.Research limitations/implicationsBecause the study focuses on the global financial crisis of 2007‐09, researchers should be careful about generalizing the results to the post‐crisis period.Practical implicationsInvestors should be aware that equity portfolio risk reduction during major crises can be hard to achieve because the average correlation coefficient between stock returns may rise significantly, crimping the efficacy of diversification.Originality/valueIt was very difficult for equity investors to shield themselves from the risk associated with the global financial crisis of 2007‐09.