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Cointegration, Information Transmission, and the Lead-Lag Effect between Industry Portfolios and the Stock Market

Troster, Victor; Penalva, Jose; Taamouti, Abderrahim; Wied, Dominik

Cointegration, Information Transmission, and the Lead-Lag Effect between Industry Portfolios and the Stock Market Thumbnail


Authors

Victor Troster

Jose Penalva

Dominik Wied



Abstract

This paper shows that lagged information transmission between industry portfolio and market prices entails cointegration. We analyze monthly industry portfolios in the US market for the period 1963-2015. We find cointegration between six industry portfolio and market prices. We show that the equilibrium error, the long-term common factor between industry portfolio and market cumulative returns, has strong predictive power for excess industry portfolio returns. In line with gradual information diffusion across connected industries, the equilibrium error proxies for changes in the investment opportunity set that lead to industry return predictability by informed investors. Forecasting models including the equilibrium error have superior forecasting performance relative to models without it, illustrating the importance of cointegration between the industry portfolio and market prices. Overall, our findings have important implications for investment and risk-management decisions, since the out-of-sample explanatory power of the equilibrium error is economically meaningful for making optimal portfolio allocations.

Citation

Troster, V., Penalva, J., Taamouti, A., & Wied, D. (2021). Cointegration, Information Transmission, and the Lead-Lag Effect between Industry Portfolios and the Stock Market. Journal of Forecasting, 40(7), 1291-1309. https://doi.org/10.1002/for.2767

Journal Article Type Article
Acceptance Date Dec 27, 2020
Online Publication Date Feb 1, 2021
Publication Date 2021-11
Deposit Date Jan 13, 2021
Publicly Available Date Feb 1, 2023
Journal Journal of Forecasting
Print ISSN 0277-6693
Electronic ISSN 1099-131X
Publisher Wiley
Peer Reviewed Peer Reviewed
Volume 40
Issue 7
Pages 1291-1309
DOI https://doi.org/10.1002/for.2767
Public URL https://durham-repository.worktribe.com/output/1281541

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Copyright Statement
This is the peer reviewed version of the following article: Troster, Victor Penalva, Jose Taamouti, Abderrahim & Wied, Dominik (2021). Cointegration, Information Transmission, and the Lead-Lag Effect between Industry Portfolios and the Stock Market. Journal of Forecasting 40(7): 1291-1309, which will be published in final form at http://onlinelibrary.wiley.com/journal/10.1002/(ISSN)1099-131X. This article may be used for non-commercial purposes in accordance With Wiley-VCH Terms and Conditions for self-archiving.





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