Why Commonality Persists?

46 Pages Posted: 8 Mar 2020

See all articles by Raja Velu

Raja Velu

Syracuse University - Whitman School of Management

Zhaoque Zhou

affiliation not provided to SSRN

Chyng Wen Tee

Singapore Management University - Lee Kong Chian School of Business

Date Written: February 10, 2020

Abstract

Studies on commonality in returns, order flows and liquidity find that the first principal component is closely aligned with the market factor. With the increasing presence of high-frequency trading, commonality in returns, order flows, and liquidity can potentially arise from the commonality in the interpretation of real-time signals. In this paper, we go beyond the first factor and show that the other dominant principal components consistently reflects investors' herding behavior, demonstrating the multi-dimensional aspect of commonality. Instead of relating the asset returns to order flows, we take both as endogenous, and provide empirical evidence showing that returns commonality is driven by investors' attention, while order flows commonality is driven by investors' sentiment. We also present a comprehensive longitudinal study of commonality and co-movement over a period in excess of two decades under a unifying market microstructure framework to demonstrate the persistence of commonality over time. Our results not only extend the knowledge about cross-sectional asset behaviors, but can also be used to develop systematic trading strategies.

Keywords: commonality, order flow and liquidity measures, co-movement, market sentiments, investor attention, principal component analysis, canonical correlation analysis, reduced rank regression

JEL Classification: G02, G14

Suggested Citation

Velu, Raja and Zhou, Zhaoque and Tee, Chyng Wen, Why Commonality Persists? (February 10, 2020). Available at SSRN: https://ssrn.com/abstract=3536015 or http://dx.doi.org/10.2139/ssrn.3536015

Raja Velu

Syracuse University - Whitman School of Management ( email )

721 University Avenue
Syracuse, NY 13244-2130
United States

Zhaoque Zhou

affiliation not provided to SSRN

Chyng Wen Tee (Contact Author)

Singapore Management University - Lee Kong Chian School of Business ( email )

50 Stamford Road
Singapore, 178899
Singapore

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