The More Connected, the Better?: New Evidence of Connectedness’ Impact on Volatility and Price Discovery Focused on the Korean Financial Sector

Abstract

This paper empirically analyzes one particular channel through which the increasing connectivity among finance companies can do harm to the Korean financial market: it can worsen the price-discovery process in the equity market. Our analysis is based on the Korean financial sector from 1990 to July 2015, including the period of the 1997 Asian crisis and the 2007-8 U.S. Financial crisis. By 'densely connected', we specifically refer to the case in which a node experiences strong lagged return spillover from and/or to itself. With data spanning the entire financial sector, we show that the more densely connected a particular financial institution is, the more volatile stock price and the less accurate stock price quality becomes. Hence we establish connectedness as an important determinant of stock price discovery. Our work is expected to help regulators and policy makers understand the full implication of introducing new policies which can make financial institutions more connected.