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Economic Links and Predictable Returns

Authors

  • LAUREN COHEN,

  • ANDREA FRAZZINI

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    • Cohen is at the Harvard Business School and NBER; Frazzini is at the University of Chicago Graduate School of Business and NBER. We would like to thank Nick Barberis, Effi Benmelech, Judy Chevalier, Kent Daniel, Doug Diamond, Gene Fama, Will Goetzmann, Ravi Jagannathan, Anil Kashyap, Josef Lakonishok, Owen Lamont, Jonathan Lewellen, Toby Moskowitz, Lubos Pastor, Lasse Pedersen, Monika Piazzesi, Joseph Piotroski, Josh Rauh, Doug Skinner, Matt Spiegel, Robert Stambaugh, Amir Sufi, Jake Thomas, Tuomo Vuolteenaho, Ivo Welch, Wei Xiong, an anonymous referee, and seminar participants at NBER, Barclays Global Investors, BSI Gamma Foundation, Chicago Quantitative Alliance, University of Chicago, American Finance Association, European Finance Association, Goldman Sachs Asset Management, Lehman Brothers, London Business School, New York University, Harvard Business School, Massachusetts Institute of Technology, Yale University, AQR Capital Management, Prudential Equity Conference, and University of California Davis Conference on Financial Markets Research for helpful comments. We also thank Wooyun Nam, Vladimir Vladimirov, and Jeri Xu for excellent research assistance, Husayn Shahrur and Jayant Kale for providing us with some of the customer–supplier data, the Chicago Quantitative Alliance and the BSI Gamma Foundation for financial support. All errors are our own.


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 return predictability across assets. Using a data set of firms' principal customers to identify a set of economically related firms, we 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.

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