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Geographic Momentum

Last Updated on 10 February, 2024 by Rejaul Karim

In the labyrinth of multinational finance, Quoc Nguyen sheds light on an intriguing phenomenon in “Geographic Momentum,” a compelling exploration spanning 42 pages. Unveiling the question of whether investors truly factor in foreign market conditions when evaluating multinational corporations, Nguyen ventures into the realm of geographic segment disclosures by US multinational companies.

The revelation is striking: stock prices seem sluggish in incorporating changes in foreign market conditions, creating a tantalizing avenue for return predictability across firms with international operations. A clever trading strategy, capitalizing on this geographic information, yields a noteworthy risk-adjusted return, challenging traditional notions of market efficiency.

The paper unfolds a narrative of investor inattention, with smaller firms and those with less coverage navigating this predictable terrain more conspicuously—a pioneering contribution to the evolving discourse on market inefficiencies and their intricate connections.

Abstract Of Paper

Do investors pay attention to foreign market conditions when they evaluate multinational corporations? Using geographic segment disclosures by US multinational companies, I find that stock prices do not promptly incorporate information regarding changes in foreign market conditions. This, in turn, generates return predictability in the cross-section of firms with foreign operations. A simple trading strategy that exploits geographic information yields risk-adjusted return of 135 basis points per month, or 16.2% per year. The predictability cannot be explained by firm’s own momentum, industry momentum, post-earnings-announcement drift, being a conglomerate, or exposure to emerging market risk. Consistent with the investor inattention hypothesis, I further document that smaller firms, as well as firms with less analyst coverage, lower institutional holdings, or more complex foreign sales compositions exhibit stronger return predictability. This paper is the first to document the predictable link between foreign country-level indices returns and US firm-level stock returns, and adds to the growing literature concerning the role of investor inattention and firm complexity in price formation.

Original paper – Download PDF

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Author

Quoc Nguyen
DePaul University

Conclusion

In summary, the study unravels a fascinating dimension in market dynamics, shedding light on investor behavior towards multinational corporations with foreign operations. The evidence points to a remarkable delay in stock prices incorporating critical information about changes in foreign market conditions, leading to substantial return predictability in the realm of firms with global footprints.

The trading strategy derived from exploiting this geographic information emerges as a robust performer, delivering a noteworthy risk-adjusted return. Importantly, this predictability remains resilient to conventional explanatory factors such as firm and industry momentum, post-earnings-announcement drift, and exposure to emerging market risk.

The findings also underscore the role of investor attention and firm complexity in shaping price formation, with smaller firms and those with less coverage exhibiting heightened return predictability. This study contributes a unique perspective to the understanding of how geographic factors influence stock returns and the nuanced interplay of market inefficiencies.

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FAQ

Q1: What is the central question addressed in the paper “Geographic Momentum,” and what does it reveal about investor behavior?

The paper explores whether investors consider foreign market conditions when evaluating multinational corporations. The findings indicate a delay in stock prices incorporating information about changes in foreign market conditions, revealing a phenomenon of investor inattention to geographic factors in the evaluation of multinational firms.

Q2: How does the study demonstrate return predictability in the cross-section of firms with foreign operations, and what is the key trading strategy introduced?

The study reveals that the delayed incorporation of information about foreign market conditions generates return predictability across firms with global operations. A trading strategy exploiting this geographic information yields a substantial risk-adjusted return of 135 basis points per month or 16.2% per year. This strategy challenges traditional notions of market efficiency.

Q3: What are the key factors contributing to return predictability, and how does the paper address the role of investor attention and firm complexity?

Return predictability remains robust even after accounting for factors such as firm and industry momentum, post-earnings-announcement drift, and exposure to emerging market risk. The paper highlights the role of investor inattention, with smaller firms and those with less analyst coverage exhibiting stronger return predictability. The study adds a unique perspective to the literature on market inefficiencies by emphasizing the impact of geographic factors on stock returns and the intricate interplay of investor behavior and firm complexity.

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