European stock market volatility connectedness: The role of country and sector membership

The literature suggests that the country in which a company is listed, i.e., its country membership, is the main determinant of its price volatility co-movements in the global stock market but, at the same time, this body of literature also recognizes the relevance of industry sector membership for understanding risk transmission. Drawing on recent advances in time series analysis, we are able to define an extensive network structure for 645 ‘large-cap’ companies from 35 European countries, and to decompose the total market volatility connectedness into its respective country and sector membership contributions. Using the firm level as our unit of analysis, we find that traditional (more aggregate) approaches, which rely on market indices to study international connectedness, present an incomplete (and, biased) picture of risk transmission between international stock markets. We show that, in general, a company’s country membership is indeed a more significant determinant than that of its sector membership; however, from a risk management perspective, there are significant heterogeneities at the company level that need to be duly considered and quantified so as to better anticipate crucial dependencies in certain countries or sectors in periods of market distress, such as that resulting from the current conflict in Ukraine and the economic sanctions being imposed. We summarize the connectedness of individual companies in a network that international risk managers and investors can use to assess global financial market dependencies and to inform their risk management practices.