Horizontal Industry Relationships and Return Predictability

56 Pages Posted: 12 Aug 2019

See all articles by Christian Schlag

Christian Schlag

Goethe University Frankfurt - Research Center SAFE

Kailin Zeng

Jiangxi University of Science and Technology

Date Written: August 9, 2019

Abstract

It has been documented that vertical customer-supplier links between industries are the basis for strong cross-sectional stock return predictability (Menzly and Ozbas (2010)). We show that robust predictability also arises from horizontal links between industries, i.e., from the fact that industries are competitors or offer products, which are substitutes for each other. These horizontally linked industries exhibit positively correlated fundamentals. The signal derived from this type of connectedness is the basis for significant alpha in sorted portfolio strategies, and informed investors take the related information into account when they form their portfolios. We thus provide evidence of return predictability based on a new type of economic links between industries not captured in previous studies.

Keywords: connected industries, information flow, return predictability

JEL Classification: G12, E44, D81

Suggested Citation

Schlag, Christian and Zeng, Kailin, Horizontal Industry Relationships and Return Predictability (August 9, 2019). SAFE Working Paper No. 256 (2019). Available at SSRN: https://ssrn.com/abstract=3436006 or http://dx.doi.org/10.2139/ssrn.3436006

Christian Schlag

Goethe University Frankfurt - Research Center SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany
+49 69 798 33699 (Phone)

Kailin Zeng (Contact Author)

Jiangxi University of Science and Technology ( email )

Ganzhou
China

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