Market Segmentation and Cross-predictability of Returns




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    • Menzly is with Nomura Global Alpha, and Ozbas is with University of Southern California Marshall School of Business. We thank an anonymous referee, an anonymous associate editor, Wayne Ferson, Cam Harvey (the editor), Chris Jones, Berk Sensoy and Mark Westerfield for helpful comments. Financial support from the Marshall General Research Fund is gratefully acknowledged.


We present evidence supporting the hypothesis that due to investor specialization and market segmentation, value-relevant information diffuses gradually in financial markets. Using the stock market as our setting, we find that (i) stocks that are in economically related supplier and customer industries cross-predict each other's returns, (ii) the magnitude of return cross-predictability declines with the number of informed investors in the market as proxied by the level of analyst coverage and institutional ownership, and (iii) changes in the stock holdings of institutional investors mirror the model trading behavior of informed investors.