Economic Causal Chain and Predictable Stock Returns

Abstract

A lead-lag effect in stock markets describes the situation where one (leading) stock return is cross-correlated with another (lagging) stock return at later times. There are various methods for stock return forecasting based on such a lead-lag effect. One of the most representative methods is based on the supply chain network. In this research, we propose a stock return forecasting method with an economic causal chain. The economic causal chain refers to a cause and effect network structure constructed by extracting a description indicating a causal relationship from the texts of Japanese financial statement summaries. We examine whether the lead-lag effect spreads to the 'effect' stock group when there is a large stock fluctuation in the 'cause' stock group in the causal chain. We confirm the profitability of the proposed strategy and the evidence of stock return predictability across causally linked firms in the Japanese stock market.