Excess Comovement of Stock Returns: Evidence from Cross-sectional Variation in Nikkei 225 Weights

Robin  Greenwood

Article | Review of Financial Studies | May 2008

Excess Comovement of Stock Returns: Evidence from Cross-sectional Variation in Nikkei 225 Weights

Abstract

In the presence of limits to arbitrage, cross-sectional variation in periodic investor demand should be related to the degree of comovement of returns. I exploit the unusual weighting system of the Nikkei 225 index in Japan to identify cross-sectional variation in periodic demand for index stocks. Relative to their weights in a value weighted index, some stocks in the Nikkei are overweighted by a factor of ten or more. Using overweighting as an instrument for the proportionality between demand shocks for index stocks, I find a strong positive relation between overweighting and the comovement of a stock with other stocks in the index, and a negative relationship between index overweighting and comovement with stocks outside of the index. Put simply, overweighted stocks have high betas. The results suggest that excess comovement of stock returns is a consequence of an institutionalized commonality in trading behavior, rather than inefficiencies related to the speed at which index stocks incorporate economy-wide information.

Keywords: Stocks; Investment; Investment Return; Market Transactions; Weight; Performance Expectations; Behavior; Japan;

Format: Print

34 pages

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Greenwood, Robin. "Excess Comovement of Stock Returns: Evidence from Cross-sectional Variation in Nikkei 225 Weights." Review of Financial Studies 21, no. 3 (May 2008): 1153–1186.

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Excess Comovement of Stock Returns: Evidence from Cross-sectional Variation in Nikkei 225 Weights

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