State-Level Business Cycles and Local Return Predictability




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    • George Korniotis (corresponding author) and Alok Kumar are at the School of Business Administration, University of Miami. We thank an anonymous referee; an anonymous Associate Editor; Aydogan Alti; Bo Becker; Sean Campbell; Jonathan Cohn; Murray Frank; David Gallagher; William Goetzmann; John Griffin; Bing Han; Cam Harvey (the Editor); Harrison Hong; Tim Loughran; Massimo Massa; Jeremy Page; Ramesh Rao; Stefan Ruenzi; Oleg Rytchkov; Oliver Spalt; Laura Starks; Sheridan Titman; Masahiro Watanabe; Scott Weisbenner; Margaret Zhu; Ning Zhu; and seminar participants at Federal Reserve Finance Forum, 2008 University of Colorado Investment Management Conference, University of Texas at Austin, 2009 WFA, Fourth Biennial McGill Conference on Global Asset Management (2009), Drexel University, DePaul University, and University of Miami for helpful comments and valuable suggestions. We are responsible for all remaining errors and omissions. Previous versions of the paper circulated under the title “Long Georgia, Short Colorado? The Geography of Return Predictability.”


This study examines whether local stock returns vary with local business cycles in a predictable manner. We find that U.S. state portfolios earn higher future returns when state-level unemployment rates are higher and housing collateral ratios are lower. During the 1978 to 2009 period, geography-based trading strategies earn annualized risk-adjusted returns of 5%. This abnormal performance reflects time-varying systematic risks and local-trading induced mispricing. Consistent with the mispricing explanation, the evidence of predictability is stronger among firms with low visibility and high local ownership. Nonlocal domestic and foreign investors arbitrage away the predictable patterns in local returns in 1 year.