Financial Contagion in International Supply-Chain Networks

Using hand-collected data on U.S. suppliers and their foreign principal corporate customers, I study the role of cross-border supply-chains for international financial contagion. Following large country-level shocks in the customer countries such as country-index return jumps and natural disasters, the dynamic conditional correlation (DCC) of stock returns between U.S. suppliers and international customers increases by 7% of a standard deviation relative to matched placebo firm-pairs. This increase is beyond any country- or industry-effects and persists for approximately 25 weeks. Consistent with a credit-chain mechanism, I find no effect of positive shocks on supplier-customer DCC and a significant increase in supplier CDS spreads following negative shocks in the customer countries. I further document that contagion is increasing with trade credit usage, customer vulnerability, and cost of bankruptcy resolution in the customer countries, and document that supply-chains contribute up to 50% of overall financial contagion at the country-level. My findings provide novel firm-level evidence on the mechanisms that link fundamentals and asset correlation.