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Where Does the Predictability from Sorting on Returns of Economically Linked Firms Come From?

Published online by Cambridge University Press:  07 December 2020

Aaron Burt  and
Christopher Hrdlicka Open the ORCID record for Christopher Hrdlicka [Opens in a new window]
Aaron Burt
Affiliation:
University of Oklahoma Price College of Businessaaronburt@ou.edu
Christopher Hrdlicka*
Affiliation:
University of Washington Foster School of Business
*
hrdlicka@uw.edu (corresponding author)
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Abstract

Cross-firm predictability among economically linked firms can arise when both firms exhibit their own momentum and their returns are contemporaneously correlated. We show that cross-firm predictability can last up to 10 years, which is hard to reconcile with an interpretation of slow information diffusion. However, it is consistent with the economically linked firms’ commonality in momentum. The contribution of each source can be found by decomposing leaders’ returns into the predictable (momentum) and news components. Sorting on each, we find that both sources contribute almost equally to 1-month predictability, whereas commonality in momentum is solely responsible for longer-horizon cross-firm predictability.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 56 , Issue 8 , December 2021 , pp. 2634 - 2658
Copyright
© The Author(s), 2020. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

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Footnotes

We are grateful to Brad Barber, Hank Bessembinder, Philip Bond, Jennifer Conrad (the editor), Tarun Chordia, John Cochrane, Ran Duchin, Thomas Gilbert, Amit Goyal, Mark Grinblatt, Jarrad Harford, Cam Harvey, Raymond Kan, Jonathan Karpoff, Roni Kisin, Ralph Koijen, Juhani Linnainmaa, Charles Martineau, $ \overset{\smile }{\mathrm{L}} $ uboš Pástor, Cesare Robotti, Sergei Sarkissian, Andy Siegel, Stephan Siegel, and Mark Westerfield and seminar participants at the University of Calgary, the University of Notre Dame, the University of Washington, the 2015 Western Finance Association (WFA) Meetings, the 2016 Northern Finance Association (NFA) meetings, and the 2015 Conference on Advances in the Analysis of Hedge Fund Strategies for helpful comments and suggestions. Any errors are our own.

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