Lead-lag Effects between Stocks Intra-industry: Evaluating Market Efficiency and Providing Trading Strategy

The efficient market hypothesis (EMH) states that stock prices reflect all available information and price changes (or return) should be unpredictable. But the lead-lag effect is a phenomenon that provides the predictability of return in the stock market. Examining the lead-lag relationship between stocks, in addition to evaluating market efficiency, provides investors with useful trading strategies.

This study has investigated the lead-lag effect between stocks within 20 industries of the Tehran Stock Exchange (which cover 75% of the market capital) from 2015 to 2020 using the vector autoregression (VAR) model.

From 20 industries in our sample, 13 industries show the lead-lag effect. In 10 industries, the return of small stocks leads to the return of big stocks within the same industry. Whereas, in the other 3 industries, the return of big stocks leads to the return of small stocks within the same industry. In addition, a stronger lead-lag effect has been observed in the computer, transportation, and metal products industries (which are relatively small industries).

These observed lead-lag relationships (or predictable returns) between stocks intra-industry show a systemic inefficiency in the Tehran Stock Exchange market. Also, the results show that in some industries of the Tehran Stock Exchange, there are potentially profitable trading strategies.