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The more connected, the better? Impact of connectedness on volatility and price discovery in the Korean financial sector

DeokJong Jeong (Department of Industrial and Systems Engineering, Korea Advanced Institute of Science and Technology, Daejeon, South Korea)
Sunyoung Park (Department of Industrial and Systems Engineering, Korea Advanced Institute of Science and Technology, Daejeon, South Korea)

Managerial Finance

ISSN: 0307-4358

Article publication date: 8 January 2018

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587

Abstract

Purpose

The purpose of this paper is to empirically analyze the effect of the increasing connectedness among financial institutions in the Korean financial market, as it affects the market microstructure in the stock market. Thus this work, first, analyzes the trend and characteristics of connectedness in the Korean financial sector. This work then demonstrates the impacts of connectedness on volatility and price discovery in the stock market.

Design/methodology/approach

The entire Korean financial sector is analyzed from January 1990 to July 2015, including the periods of the 1997 Asian crisis and the 2007/2008 global financial crisis. This paper quantifies the connectedness between financial institutions using network methodology. Densely connectedness specifically refers to the cases in which a node experiences strong-lagged return spillover from and/or to itself.

Findings

Connectedness is established as an important determinant of stock price discovery. This paper illustrates that connectedness increases on significant economic events such as the 1997 Asian crisis and the 2007/2008 global financial crisis. Furthermore, this paper demonstrates that the more densely connected a particular financial institution, the more volatile the stock price and the less accurate the stock price quality.

Research limitations/implications

Understanding the financial system from a network perspective has been on the rise after the 2007/2008 global financial crisis. This work helps regulators and policy makers understand the full implications of introducing new policies that can more closely connect financial institutions.

Originality/value

This paper precisely captures financial institutions’ connectedness by including all types of financial institutions at the micro level. Additionally, this paper links connectedness to market microstructure in the stock market.

Keywords

Acknowledgements

The authors sincerely thank the editor and two anonymous reviewers for their constructive comments. The authors would like to thank Heesu Roh (KAIST) for his helpful suggestions and insightful comments. The authors also thank useful comments on the 10th international conference on Asia-Pacific financial markets (December 2015, the Korean Securities Association). This work was supported by the National Research Foundation of Korea (NRF) Grant funded by the Korean Government (Ministry of Science, ICT and Future Planning No. NRF-2013R1A1A1076066).

Citation

Jeong, D. and Park, S. (2018), "The more connected, the better? Impact of connectedness on volatility and price discovery in the Korean financial sector", Managerial Finance, Vol. 44 No. 1, pp. 46-73. https://doi.org/10.1108/MF-09-2016-0277

Publisher

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Emerald Publishing Limited

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