81 Pages Posted: 21 May 2019 Last revised: 27 Aug 2020
Date Written: February 4, 2020
A large literature explores whether asset returns comove in excess of what can be explained by fundamentals, thus suggesting the existence of frictions or behavioral biases. However, we show that comovement is a ubiquitous feature of asset returns that will arise in the presence of latent or mismeasured systematic factors. Therefore, existing empirical tests cannot distinguish between alternate sources of comovement, and several documented interpretations of comovement in favor of particular explanations are premature and warrant reconsideration. We propose new statistical tests of excess comovement that account for latent factors and that exploit additional implications of market efficiency.
Keywords: excess comovement, fundamentals, rational markets, behavioral finance, stock returns, factor models
JEL Classification: G11, G12, G14, G40
Suggested Citation: Suggested Citation