Burt, A., & Hrdlicka, C.M. (2020). Where Does the Predictability from Sorting on Returns of Economically Linked Firms Come From?

Previous studies document failures of market efficiency with price discovery requiring up to a year. These studies use network based measures of information diffusion: the long-short alpha of portfolios formed sorting on the preceding returns of firms economically linked to portfolio firms. Correlated alphas between linked firms bias these measures. Existing studies have monthly biases as large as a factor of two. This bias creates predictability even after price discovery completes. Subtracting the predicted return from the sorting firms’ returns removes this bias. Eliminating this bias reveals a more efficient market than previously documented: price discovery takes one month. [Read More]