State-Level Business Cycles and Local Return Predictability

89 Pages Posted: 19 Feb 2008 Last revised: 20 Apr 2012

See all articles by George M. Korniotis

George M. Korniotis

University of Miami; Miami Business School; University of Miami - Behavioral Decision Making Cluster

Alok Kumar

University of Miami - School of Business Administration

Date Written: March 6, 2012

Abstract

This study examines whether local stock returns vary with local business cycles in a predictable manner. Our key conjecture is that local stock prices would decline and the average future returns would rise during local recessions as local risk aversion increases and local risk sharing abilities decline. Consistent with this conjecture, we find that U.S. state portfolios earn higher future returns when state-level unemployment rates are higher and housing collateral ratios are lower. During the 1978 to 2009 period, geography-based trading strategies that exploit this predictable pattern earn an annualized risk-adjusted performance of about five percent. This abnormal performance can be attributed to time-varying portfolio exposures to U.S. systematic risk factors and mispricing generated by coordinated local trading. Consistent with the mispricing explanation, the evidence of predictability is stronger among firms with low visibility and high local ownership. Nonlocal domestic and foreign investors arbitrage away the predictable patterns in local returns in about a year.

Suggested Citation

Korniotis, George M. and Kumar, Alok, State-Level Business Cycles and Local Return Predictability (March 6, 2012). Journal of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1094560 or http://dx.doi.org/10.2139/ssrn.1094560

George M. Korniotis

University of Miami ( email )

P.O. Box 248094
Coral Gables, FL 33124-6552
United States
305-284-5728 (Phone)

Miami Business School ( email )

University of Miami - Behavioral Decision Making Cluster ( email )

5250 University Drive
Coral Gables, FL 33124
United States

Alok Kumar (Contact Author)

University of Miami - School of Business Administration ( email )

514 Jenkins Building
Department of Finance
Coral Gables, FL 33124-6552
United States
305-284-1882 (Phone)

HOME PAGE: http://moya.bus.miami.edu/~akumar

Register to save articles to
your library

Register

Paper statistics

Downloads
1,195
rank
15,708
Abstract Views
5,336
PlumX Metrics