Local Demand Shocks, Excess Comovement and Return Predictability
66 Pages Posted: 2 Mar 2013 Last revised: 26 Sep 2018
Date Written: September 20, 2018
I investigate the importance of local demand shocks on excess comovements and return predictability for 4560 twin-pairs of Exchange-Traded Funds (ETFs) from 15 country-pairs. The returns on ETFs traded in the same country comove excessively with one another. These comovements are stronger for funds with greater liquidity and more competitors in the local market. In contrast, comovements are not materially different among ETFs that are attractive to fundamental (factor) investors. A local measure of mispricing, based on price-deviations between ETFs and their foreign peers, strongly predicts return reversals not only for ETFs, but also for the local stock market. Betting against local mispricing yields significant abnormal returns of up to 25 percent per year after trading costs.
Keywords: Preferred Habitat; Correlated Demand; Mispricing; Arbitrage; Comovement; Return Predictability.
JEL Classification: G12, G14, G15, G23
Suggested Citation: Suggested Citation