TIME‐VARYING FACTORS AND CROSS‐AUTOCORRELATIONS IN SHORT‐HORIZON STOCK RETURNS

Abstract

AbstractIn this paper I show that the lead‐lag pattern between large and small market value portfolio returns is consistent with differential variations in their expected return components. I find that the larger predictability of returns on the portfolio of small stocks may be due to a higher exposure of these firms to persistent (time‐varying) latent factors. Additional evidence suggests that the asymmetric predictability cannot be fully explained by lagged price adjustments to common factor shocks: (i) lagged returns on large stocks do not have a strong causal effect on returns on small stocks; (ii) trading volume is positively related to own‐ and cross‐autocorrelations in weekly portfolio returns; and (iii) significant cross‐autocorrelation exists between current returns on large stocks and lagged returns on small stocks when trading volume is high.