Industry Information Diffusion and the Lead-Lag Effect in Stock Returns

Abstract

This paper argues that slow diffusion of common information is a leading cause of the lead-lag effect in stock returns. I find that the lead-lag effect is predominantly an intra-industry phenomenon: returns on big firms lead returns on small firms within the same industry. Once this effect is accounted for, little evidence of predictability across industries can be found. Furthermore, this effect is largely driven by sluggish adjustment to negative information. Industry leaders lead industry followers; value firms lead growth firms (within the same industry); firms with low idiosyncratic volatility lead their highly volatile industry peers, controlling for firm size. Small, volatile, less competitive and neglected industries experience a more pronounced lead-lag effect. Finally, the intra-industry lead-lag effect drives the industry momentum anomaly.

JEL Classification: G12, G14