This thesis is composed of three independent essays on customer-supplier networks and financial markets. The first chapter, entitled "Economic Links and Return Volatility", is co-authored with Keyi Zhang and Ramazan Gencay. This study investigates the propagation of stock return volatility along supply chains. Our results show that the effect of customer volatility is approximately 10 times as large as trading volume on supplier's volatility. Our findings are robust to controlling for variables capturing the time-series properties of volatility and a set of idiosyncratic, industry and market factors; tested under various assumptions regarding the activeness of customer-supplier linkages; and to different estimation methods. Our out-of-sample tests provide consistent evidence that incorporating customer channel improves volatility forecasting. Furthermore, the transfer of volatility is more pronounced when investors are more aware of customer-supplier linkages. The second chapter, entitled "Resilience to the Financial Crisis in Customer-Supplier Networks" is also co-authored with Ramazan Gencay and Keyi Zhang. Inspired by the Capital Asset Pricing Model (CAPM) beta, we construct customer and supplier betas to separately investigate potentially different properties of downstream and upstream linkages. With the adjacency matrix acting as a "filter" to extract each company's return covariances with its trading partners, the cross-sectional dependence contained in the customer-supplier network is summarized by our betas. We explore how these two betas are related to a company's resilience to the financial crisis of 2008-2009. We observe that a higher customer beta is generally associated with more resilience during the crisis. The third chapter, entitled "Economic Links and Credit Spreads", is co-authored with Ramazan Gencay, Daniele Signori, Yi Xue and Keyi Zhang. This paper has been published in the Journal of Banking and Finance. This study describes a model of financial networks that is suitable for the construction of proxies for counterparty risk. We find that, for each supplier, counterparties' leverage and option implied volatilities are significant determinants of corporate credit spreads in the period after the 2008-2009 U.S. recession. Our findings are robust after controlling for several idiosyncratic, industry, and market factors.
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Thesis advisor: Gencay, Ramazan
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