Article | Journal of Finance | August 2008

Economic Links and Predictable Returns

by Lauren Cohen and Andrea Frazzini

Abstract

This paper finds evidence of return predictability across economically linked firms. We test the hypothesis that in the presence of investors subject to attention constraints, stock prices do not promptly incorporate news about economically related firms, generating this return predictability across assets. We use a dataset of firms' principal customers to identify a set of economically related firms, and show that stock prices do not incorporate news involving related firms, generating predictable subsequent price moves. A long/short equity strategy based on this effect yields monthly alphas of over 150 basis points, or over 18 percent per year.

Keywords: Economics; Price; Assets; Data and Data Sets; Customers; Stocks; Equity; Strategy; Investment Return; Forecasting and Prediction;

Citation:

Cohen, Lauren, and Andrea Frazzini. "Economic Links and Predictable Returns." Journal of Finance 63, no. 4 (August 2008). (Winner of Chicago Quantitative Alliance Academic Paper Competition. First Prize presented by Chicago Quantitative Alliance. Winner of Smith Breeden Prize. Distinguished Paper For distinguished papers published in the Journal of Finance presented by Smith Breeden Associates, Inc. Winner of BSI Gamma Foundation Research Grant presented by BSI Gamma Foundation​.)