The Pricing of Spatial Linkages in Companies’ Underlying Assets

51 Pages Posted: 24 Feb 2017

See all articles by Bing Zhu

Bing Zhu

University of Cambridge - Faculty of Economics

Stanimira Milcheva

University College London

Date Written: July 23, 2016

Abstract

Spatial linkages in returns have not yet received much attention in an asset pricing context, however, they can capture important information about idiosyncratic externalities associated with firms’ holdings. We explain abnormal returns of real estate companies by modelling the spatial comovement across their underlying assets. We connect stocks using the location of their underlying assets, the properties. Comovement arises from price pressures associated with property idiosyncrasies. We show that spatial linkages across the firms’ holdings explain some of the variation in abnormal returns, controlling for exposure to systematic return factors and firm characteristics. We propose a trading strategy which exploits the information contained in the spatial linkages of the underlying assets. We show that a long-short hedge strategy which buys the stocks that experience an increase in the price if their connected stocks have also gone up and sells the stocks that experience a drop if their connected stocks have also gone down in price can earn a non-market return of an annual 12%.

Keywords: Asset pricing, Factor Models, Spatial Weights, Properties, Distance, Hedging Strategies

JEL Classification: G11, G12, C21, C23

Suggested Citation

Zhu, Bing and Milcheva, Stanimira, The Pricing of Spatial Linkages in Companies’ Underlying Assets (July 23, 2016). Available at SSRN: https://ssrn.com/abstract=2922700 or http://dx.doi.org/10.2139/ssrn.2922700

Bing Zhu

University of Cambridge - Faculty of Economics ( email )

Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom

Stanimira Milcheva (Contact Author)

University College London ( email )

1-19 Torrington Place
Department of Construction and Project Management
London, London WC1E 7HB
United Kingdom

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