The Positive Similarity of Company Filings and the Cross-Section of Stock Returns

Abstract

It is already well-documented that textual analysis of 10-K & 10-Qs can be largely profitable. This research studies the similarity of language used in the filings using data which enables to analyze what type of language is similar. Results show that the similarity of the positive language is the most profitable option. From a practical point of view, the positive similarity effect is examined. Results show that the lowest positive similarity stocks significantly outperform the highest positive similarity stocks. The effect cannot be explained by the common asset pricing models, nor by the change of sentiment in the financial reports. Therefore, the positive similarity effect could be considered as a distinct anomaly in the financial markets. In the long-only implementation, the strategy is highly profitable, and in the long-short implementation, the strategy has impressive consistency and risk-adjusted return (0.84).