On cross-stock predictability of peer return gaps in China

• Our proposed Peer Return Gap (PRG) variable predicts stock returns in China. • A portfolio strategy based on the PRG generates significant abnormal returns. • We provide empirical evidence of cross-stock predictability in Chinese stock markets. While many studies document cross-stock predictability where returns of some stocks pre- dict returns of other similar stocks, most evidence comes from US markets. Following Chen et al. (2019), we identify peer firms based on historical return similarity and construct a Peer Return Gap (PRG) measure, defined as the difference between a stock’s lagged return and its peers’ returns. Our empirical evidence from Chinese markets shows that past-return-linked peers strongly predict focal firm returns. A long-short portfolio sorted on PRG generates an equal-weighted monthly return of 1.26% ( t = 3 . 81) and a Fama-French five-factor alpha of 1.10% ( t = 2 . 86). These abnormal returns remain unexplained by several alternative factor models.