An Analysis Of The Return Dependence Between Large And Small Capitalization Stocks

Abstract

In a Seemingly Unrelated Regression Estimation (SURE) framework, we examine the Granger-causal linkages between the monthly returns of small and large market capitalization stocks. Our initial results confirm that the returns of large stocks lead those of smaller stocks as reported by Lo and MacKinlay (1988). However, such causality disappears once we account for the small-firm January effect, the feedback of monetary policy, and the expectation of a recession. Thus, we attribute the lead-lag pattern correlation to model misspecification that fails to incorporate the macroeconomic environment and its seasonality.