Abnormal Returns or Mismeasured Risk? Network Effects and Risk Spillover in Stock Returns

Recent event study literature has highlighted abnormal stock returns particularly in short event windows. A common explanation is cross-correlation of stock returns that are often enhanced during periods of sharp market movements. This suggests misspecification of the underlying factor model, typically the Fama-French model. By drawing upon recent panel data literature with cross-section dependence, we argue that the Fame-French factor model can be enriched by allowing explicitly for network effects between stock returns. We show that recent empirical work is consistent with the above interpretation and advance some hypotheses along which new structural models for stock returns may be developed. Applied to data on stock returns for the 30 Dow Jones Industrial Average (DJIA) stocks, our framework provides exciting new insights.