FIN-01-064

Comovement

November 2001

Nicholas Barberis, Andrei Shleifer and Jeffrey Wurgler

ABSTRACT

A number of studies have identified patterns of positive correlation of returns, or comovement, among different traded securities. We distinguish three views of such co- movement. The traditional "fundamentals" view explains the comovement of securities through positive correlations in the rational determinants of their values, such as cash ows or discount rates. "Category-based" comovement occurs when investors classify different securities into the same asset class and shift resources in and out of this class in correlated ways. A related phenomenon of "habitat-based" comovement arises when a group of investors restricts its trading to a given set of securities, and moves in and out of that set in tandem.
We present models of each of the three types of comovement, and then assess them empirically using data on stock inclusions into and deletions from the S&P 500 index. Index changes are noteworthy because they change a stock's category and investor clientele (habitat), but do not change its fundamentals. We find that when a stock is added to the index, its beta and R-squared with respect to the index increase, while its beta with respect to stocks outside the index falls. The converse happens when a stock is deleted. These results are broadly supportive ofthe category and habitat views of comovement, but not of the fundamentals view. More generally, we argue that these non-traditional views may help explain other instances of comovement in the data.

Nicholas Barberis
Institution: University of Chicago

Andrei Shleifer
Institution: Harvard University
Telephone: (617) 495-5046
Fax: (617) 496-1708
Email: ashleifer@harvard.edu
Homepage:http://post.economics.harvard.edu/faculty/shleifer/shleifer.html

Jeffrey Wurgler
Institution: Stern School of Business, New York University, 44th West 4th Street, New York, NY 10012
Telephone: (212) 998-0367
Fax: (212) 995-4233
Email: jwurgler@stern.nyu.edu
Homepage: http://www.stern.nyu.edu/~jwurgler/

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