Social and relationship capital and idiosyncratic volatility: is there a nexus? Evidence from the European financial market

This study investigates the impact of social and relationship capital (SRC) on the volatility of stock returns for financial companies in the European Union. While prior research has examined the link between SRC and market returns, this study uniquely explores its influence on both systematic and idiosyncratic components of volatility. Using a sample of 140 EU banking, insurance, and asset management firms from 2002 to 2021, we apply Marshall’s (2015) model to decompose total volatility. The findings reveal that firms with high SRC typically exhibit greater total volatility, largely driven by systematic risk, whereas low-SRC firms are more influenced by idiosyncratic factors. These results are robust across various specifications, including lagged data and sector-specific analyses. This study underscores the importance of SRC for financial intermediaries. Its implications are multifaceted. For investors, high-SRC firms align more closely with market movements, facilitating market-oriented strategies but offering fewer diversification benefits, whereas low-SRC firms expose portfolios to greater firm-specific risks. For regulators, the evidence underscores the role of SRC in shaping risk profiles, informing supervisory practices that increasingly incorporate ESG considerations. Finally, for financial institutions, SRC emerges as a driver of stakeholder trust and reputation and a determinant of exposure to systematic shocks.