This study examines how cyber risk propagates through the financial system and contributes to systemic financial instability. It further explores the role of market sentiment, particularly fear triggered by cyber incidents, as a key channel amplifying the contagion of cyber risk across different financial segments.
We apply a quantile vector autoregressive (QVAR) connectedness approach to capture the asymmetric and state-dependent transmission of cyber risk shocks under varying market conditions (bearish, normal, bullish). The analysis uses daily data from January 2, 2020, to May 31, 2022, covering four financial instability indicators from the US Office of Financial Research (OFR), a Twitter-based global cyber risk index and CNN’s Fear and Greed Index. To ensure robustness, we complement the quantile analysis with a Time-Varying Parameter VAR (TVP-VAR) model, which confirms the stability of the identified spillover patterns over time.
The results show that cyber risk is both a transmitter and an amplifier of financial instability. Its impact is particularly strong during bearish conditions, where it exacerbates funding liquidity stress and banking vulnerability. Market sentiment emerges as a powerful transmission mechanism that intensifies the contagion of cyber risk across financial sectors. Cyber risk also reacts to instability and fear, reinforcing systemic feedback loops.
Our findings highlight the urgent need to integrate cyber risk into macroprudential frameworks and financial stability monitoring. Policymakers should develop international coordination mechanisms, including shared cyber risk assessment protocols, cross-border crisis management procedures and dedicated platforms for real-time information exchange. Regulatory authorities must also consider sentiment-sensitive liquidity support tools to limit the amplification of shocks during periods of heightened cyber anxiety.
This paper is among the first to examine the dynamic relationship between cyber risk, financial instability and market sentiment using a quantile connectedness framework. It highlights the dual role of cyber risk, both as a transmitter and a receiver of shocks within the financial system depending on prevailing market conditions. Furthermore, the study offers novel policy insights into managing cyber-induced contagion under different market regimes, particularly by integrating behavioral and systemic dimensions into financial stability frameworks.
