Technological Links and Return Predictability

Employing a classic measure of technological closeness between firms, we show that the returns of technology-linked firms have strong predictive power for focal firm returns.  A long-short strategy based on this effect yields monthly alpha of 117 basis points.  This effect is distinct from industry momentum and is not easily attributable to risk-based explanations.  It is more pronounced for focal firms that: (a) have a more intense and specific technology focus, (b) receive lower investor attention, and (c) are more difficult to arbitrage.  Our results are broadly consistent with sluggish price adjustment to more nuanced technological news.