Too Sensitive to Fail: The Impact of Sentiment Connectedness on Stock Price Crash Risk

Area of Science:

• Financial Economics
• Behavioral Finance
• Network Analysis

Background:

• Investor sentiment significantly influences stock prices.
• Understanding sentiment spillover networks is crucial for market stability.
• Stock price crash risk remains a key concern for investors and regulators.

Purpose of the Study:

• To investigate the relationship between investor sentiment spillover networks and stock price crash risk.
• To assess the impact of sentiment connectedness on the likelihood of firm-level stock price crashes.
• To differentiate the effects of network-level sentiment from individual firm sentiment on crash risk.

Main Methods:

• Analysis of a sample of S&P 500 stocks.
• Construction and examination of an investor sentiment spillover network.
• Econometric analysis controlling for stock price synchronicity, accounting conservatism, and corporate governance.

Main Results:

• Firms with higher sentiment connectedness exhibit a greater propensity for stock price crashes.
• Sentiment connectedness, rather than individual firm sentiment, is the primary driver of crash risk, especially during market extremes.
• The findings are robust to various control variables.

Conclusions:

• Investor sentiment connectedness within a network significantly elevates stock price crash risk.
• Risk management strategies should consider the systemic effects of sentiment spillovers.
• Regulatory bodies should monitor sentiment connectedness to ensure market stability.