Capturing Early Warning Signal for Financial Crisis from the Dynamics of Stock Market Networks: Evidence from North American and Asian Stock Markets

The stakeholders in the stock markets use their interpretation of market condition, speculation and information available to them to make their trading decisions. This results in complex interactions between them and eventually the stock markets form a complex system where the stock price of various firms show an emergent behavior that is difficult to predict. One way to study the long term behavior of the interaction between stocks in the stock market is to represent the stock market data as a network and study the dynamics of these networks. Several studies on stock market networks have been reported in the literature but most of them have either considered the static properties of the network or the dynamics of the network for a particular country. We have derived the network model from the cross-correlations between daily returns of stocks using the panel data obtained from Bloomberg for some selected North American and Asian stock markets. We have studied the dynamics of some of the metrics such as the mean of the cross-correlation coefficients between the stocks, edge density of the networks for various stock markets and investigated whether there is any significant anomaly evident in their dynamics and found some interesting patterns. Our study shows that though there are some regional influences on the network dynamics but there is some global trend showing significant deviation from the average value of these metrics across stock markets from both the continents around the recent financial crisis during 2008-09. Such peculiarity in their behavior around some specific time period shows potential for its use as one of the early warning signals for a financial crisis. JEL Classification: G01, G14, G15