Geographic Links and Predictable Returns

Using detailed information about establishments owned by U.S. public firms, we construct a novel measure of geographic linkage between firms. We show that the returns of geography-linked firms have strong predictive power for focal firm returns and fundamentals. A long-short strategy based on this effect yields monthly value-weighted alpha of approximately 60 basis points. This effect is distinct from other cross-firm return predictability and is not easily attributable to risk-based explanations. It is more pronounced for focal firms that receive lower investor attention, are more costly to arbitrage, and during high sentiment periods. In addition, we find sell-side analysts similarly underreact, as their forecast revisions of geography-linked firms predict their future revisions of focal firms. Using natural disasters as localized shocks, we provide evidence that the lead-lag relation results from shock spillover among geographic peers in addition to their common exposure to the regional economy.