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Sebastian Müller, Economic Links and Cross-Predictability of Stock Returns: Evidence from Characteristic-Based “Styles”, Review of Finance, Volume 23, Issue 2, March 2019, Pages 363–395, https://doi.org/10.1093/rof/rfx033
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Abstract
Prior research has shown that information diffuses gradually across stocks that are economically linked at the industry level. I document a similar pattern when stock portfolios are formed based on characteristics that are used in the anomaly literature (e.g., size, value, asset growth). Specifically, characteristics are useful to identify economic links, and earnings surprises contain information about future returns of other firms that share similar characteristics (i.e., “similar-style” firms). Such style-based earnings surprises can be used to predict style returns in the time series. For the cross-section of stocks, I create a composite style-based earnings surprise measure (SESM), which generates an equal-weighted (value-weighted) long–short strategy return of 167 (101) basis points per month. I do not find that industry spillovers, the traditional post-earnings announcement drift, unconditional abnormal style returns or risk can explain the return predictability. My findings suggest a further channel of gradual information diffusion in security markets.
