This study examines the lead-lag patterns on the European markets between returns on portfolios sorted by size. Additionally, we test for two novel factors to explain lead-lag effects – size distribution and market efficiency. A chief separation between countries is established based on stock market development, and lead-lag structures are analyzed in the context of this partition. Country-by-country regressions are employed to prove the leading role of large company returns over small company returns. A measure of the lead-lag effect is developed in the form of the speed of adjustment of small firm returns to large firm returns. A pooled regression is performed in order to shed light over additional determinant factors of lead-lag patterns and a distinct size of lead-lag effects in emerging and advanced economies. Our results show that size is the underlying determinant of large portfolios leading small ones, while there is only partial support to validate that market inefficiencies can cause lead-lag effects. Also, we find that size heterogeneity widens lead-lag effects in developed markets.
Table of Contents
1. Introduction
2. Literature review
2.1. Developed countries
2.2. Emerging countries
2.3. Assumptions
3. Methodology
3.1. Country-by-country regressions
3.2. Speed of adjustment measurement
3.3. Market efficiency measurement
3.4. Size distribution measurement
3.5. Pooled regression
4. Data
5. Results
5.1. Country-by-country regressions
5.2. Pooled regression
6. Conclusions
Research Objectives and Themes
The primary objective of this study is to analyze size-driven lead-lag patterns in both emerging and developed European markets to determine if the forecasting power of large-cap stock returns over small-cap returns varies significantly based on the level of market development.
- Analysis of size-driven lead-lag effects in European markets.
- Testing novel explanatory factors: size distribution and market efficiency.
- Comparative examination of emerging versus developed economies.
- Development of a speed of adjustment measure for portfolio returns.
- Investigation into whether size heterogeneity drives predictable return patterns.
Excerpt from the Book
1. Introduction
Contrary to the efficient market hypothesis, there is irrefutable support that short-term horizon stock returns are predictable. Advocates of this paradigm suggest that stock prices do not follow a random walk as implied by Fama (1970) since significant deviations can be observed in the form of autocorrelation and cross-serial correlation of short-term portfolio returns (Lo and MacKinlay, 1988). Closely related to the predictability of short-term stock prices, numerous studies have examined whether portfolios formed on specific characteristics could be ascribed forecasting power over other portfolios.
Amongst the abovementioned studies, the present paper focuses on predictable patterns of stock returns determined by size. This study analyzes size-driven lead-lag effects whereby movements in large capitalization stocks lead in time changes of small capitalization stocks. Returns of large companies hence gain forecasting power over returns of small companies, giving rise to movements that could be anticipated and exploited. Additionally, we explore new causal factors of the size-related lead-lag effect, namely size dispersion and market efficiency.
Starting with the seminal work of Lo and MacKinlay (1990), extensive literature has focused on studying the driving forces of lead-lag effects. Amongst these, lead-lag relationships are documented between portfolios sorted on size, volume, institutional ownership and analyst coverage. In an approximately universal manner size has proved to be an underlying factor of short-term portfolio predictability. However, most studies are investigating developed countries, while less emphasis is put on emerging markets. Having considered this research gap, the purpose of this study is to examine size-driven lead-lag patterns in both emerging and developed European markets under a common methodology, following the guidelines of Brennan, Jegadeesh and Swaminathan (1993).
Summary of Chapters
1. Introduction: This chapter introduces the research topic of size-driven lead-lag effects in European stock markets and outlines the study's objective to examine these patterns across emerging and developed economies.
2. Literature review: This section provides an overview of existing studies on lead-lag relationships, categorizing findings for developed and emerging markets and defining the foundational assumptions of the study.
3. Methodology: This chapter details the empirical approach, including the VAR framework, the measurement of adjustment speed, market efficiency tests, and the pooled regression model.
4. Data: This section describes the dataset used, consisting of daily returns from ten European countries over a 20-year period, and explains the criteria for portfolio formation.
5. Results: This chapter presents the empirical findings from both the country-by-country regressions and the pooled regression analysis, testing the hypotheses regarding market development and lead-lag drivers.
6. Conclusions: The final chapter summarizes the main findings, confirms that size distribution is a key driver of lead-lag effects, and suggests implications for future research.
Keywords
lead-lag, stock returns predictability, determinants of lead-lag, emerging markets, developed markets, market efficiency, size distribution, portfolio returns, VAR methodology, small capitalization, large capitalization, cross-autocorrelation, financial integration, European markets, size heterogeneity.
Frequently Asked Questions
What is the core focus of this research paper?
The paper examines whether the returns of large-capitalization stock portfolios provide predictive power over small-capitalization portfolios, specifically analyzing if these lead-lag patterns differ between emerging and developed European markets.
What are the central thematic fields covered?
The study centers on asset pricing anomalies, specifically lead-lag effects, market efficiency, the impact of size distribution, and the comparative analysis of stock market development levels.
What is the primary research question?
The research asks if the size-driven lead-lag effect varies between emerging and developed economies and whether factors such as size distribution and market efficiency can explain these potential differences.
Which scientific methods are utilized?
The author employs a Vector Autoregressive (VAR) framework for individual country analysis, a Granger causality test to verify information flow, and a pooled regression analysis to test the impact of market-wide factors on the speed of adjustment.
What does the main body of the work address?
The main body covers the theoretical literature, a detailed methodology for measuring return adjustment speeds, the data preparation process, and the subsequent empirical results derived from cross-country and pooled analyses.
Which keywords characterize this work?
Key terms include lead-lag, stock returns predictability, market efficiency, size distribution, cross-autocorrelation, and emerging versus developed markets.
How is the "speed of adjustment" measured in this study?
The study uses a logit transformation based on an OLS regression of small portfolio returns against lagged large portfolio returns to capture how quickly small firms incorporate market information.
What role does the "size distribution" play in the findings?
The results show that size heterogeneity is a significant underlying determinant; a more heterogeneous size distribution within a market index generally leads to more pronounced lead-lag effects.
Does the study find a clear distinction between emerging and developed markets?
No, the study concludes that there is no universal distinction in lead-lag structures based solely on the classification of a market as emerging or developed, as individual country profiles significantly influence the results.
- Arbeit zitieren
- Irina Prodan (Autor:in), 2012, The leading role of large capitalization portfolio returns over small capitalization portfolio returns, München, GRIN Verlag, https://www.hausarbeiten.de/document/200410
