Emerald Management Review:
Economic links and predictable returns

Abstract:

Purpose - To use economic links between firms to test whether share prices embody new information immediately.

Design/methodology/approach - Reviews prior studies of investor inattention. Tests for investor inattention by using publicly available information and important information on which they should act. Selects 11,484 unique supplier-customer relationships between 1980 and 2004, taking share prices six months after financial year-end. Controls for size, book-to-market, number of customers and percentage of sales per customer, and for being in the same industry. Adds characteristics of the links, and correlates the returns of each pair. Presents value- and equal-weighted excess returns with three to five factor alpha, for quintile portfolios of customers ranked on a monthly basis. Calculates underreaction coefficients, and runs cross-sectional Fama-MacBeth forecasting regressions of individual stock returns,

Findings - Finds that investors fail to react to news affecting customers, despite common knowledge of events and of the importance of a customer to its supplier. Shows that a momentum strategy of buying supplier shares, when the customer has a positive shock, generates significant and robust returns. Successfully predicts returns on a monthly basis.

Research limitations/implications - Proposes research into the types of information and delivery paths that do grab investors' attention, and into its generalizability.

Originality/value - Presents an ingenious and rich analysis of imperfect rational expectations that has implications for asset pricing models.

Keywords:

Article Type:

Research paper

Reference:

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