Feedback Loops in Industry Trade Networks and the Term Structure of Momentum Profits
48 Pages Posted: 10 Dec 2016 Last revised: 7 Jul 2018
Date Written: July 5, 2018
Industries are economically linked through customer-supplier trade flows. We show theoretically and empirically that industry shocks propagating along this inter-sectoral trade network can feed back to the originating industry, causing an "echo" -- intermediate-term autocorrelation in returns. Adopting techniques from graph theory, we find that the strength of the trade network feedback is a crucial determinant of the echo effect in industry returns. Returns of the echo strategy implemented within high-feedback strength industries reach 1% monthly. Consistent with limited-information models, the relation between feedback strength and echo profits is strongest in industries with information diffusion frictions, such as low analyst coverage, along the feedback loop. Overall, our results identify inter-sectoral trade networks as important conduits of industry shocks and provide the first explanation for the echo effect.
Keywords: Industry trade networks, echo, stock returns, information diffusion, inter-sectoral input-output links, momentum, customer-supplier product market networks
JEL Classification: G12, G14, G17
Suggested Citation: Suggested Citation