A cross sectional analysis of the excess comovement of stock returns
By: Robin Greenwood
Contributors: Harvard Business School. Division of Research
Series: Working paper / Division of Research, Harvard Business School -- 05-069; Working paper (Harvard Business School. Division of Research) -- 05-069
Publisher: Division of Research, Harvard Business School
Published: 2005
Place of publication: Boston
Language: eng
Number of pages: 46
Description: In the presence of limits to arbitrage, cross-sectional variation in periodic investor demand should be related to the degree of comovement of returns. I exploit the unusual weighting system of the Nikkei 225 index in Japan to identify cross-sectional variation in periodic demand for index stocks. Relative to their weights in a value weighted index, some stocks in the Nikkei are overweighted by a factor of ten or more. Using overweighting as an instrument for the proportionality between demand shocks for index stocks, I find a strong positive relation between overweighting and the comovement of a stock with other stocks in the index, and a negative relationship between index overweighting and comovement with stocks outside of the index. Put simply, overweighted stocks have high betas. The results suggest that excess comovement of stock returns is a consequence of an institutionalized commonality in trading behavior, rather than inefficiencies related to the speed at which index stocks incorporate economy-wide information.
Notes: "First draft: September 2004, Revised: March 2005."

Includes bibliographical references.