Where Does the Predictability from Sorting on Returns of Economically Linked Firms Come From?

Forthcoming, Journal of Financial and Quantitative Analysis

39 Pages Posted: 12 Apr 2014 Last revised: 26 Feb 2020

See all articles by Aaron Burt

Aaron Burt

University of Oklahoma - Division of Finance

Christopher M. Hrdlicka

University of Washington - Michael G. Foster School of Business

Date Written: January 31, 2020

Abstract

Cross-firm predictability among economically linked firms can arise when both firms exhibit own-momentum and their returns are contemporaneously correlated. We show that cross-firm predictability can last up to 10 years, which is hard to reconcile with an interpretation of slow information diffusion. However, it is consistent with the economically linked firms' commonality in momentum. The contribution of each source can be found by decomposing leaders' returns into the predictable (momentum) and news components. Sorting on each, we find that both sources contribute almost equally to 1-month predictability, while commonality in momentum is solely responsible for longer-horizon cross-firm predictability.

Keywords: model missspecification, price discovery, economic links, return predictability, information diffusion, market efficiency, investor inattention, limits to arbitrage, lead-lag effect, networks

JEL Classification: G10, G12, G14

Suggested Citation

Burt, Aaron Paul and Hrdlicka, Christopher M., Where Does the Predictability from Sorting on Returns of Economically Linked Firms Come From? (January 31, 2020). Forthcoming, Journal of Financial and Quantitative Analysis, Available at SSRN: https://ssrn.com/abstract=2423795 or http://dx.doi.org/10.2139/ssrn.2423795

Aaron Paul Burt

University of Oklahoma - Division of Finance ( email )

Norman, OK 73019
United States

HOME PAGE: http://sites.google.com/sites/aaronburt

Christopher M. Hrdlicka (Contact Author)

University of Washington - Michael G. Foster School of Business ( email )

Box 353200
Seattle, WA 98195
United States
206.616.0332 (Phone)
206.542.7472 (Fax)

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