The interaction of switching and lead-lag effects in the Australian stock market

Abstract

This study draws on the lead-lag literature to extend the Barberis and Shleifer (2003) model of switching. While the Barberis and Shleifer model assumes stocks in a given category are of equal importance, this study assumes a category comprises leader stocks and follower stocks. The sentiment of investors towards categories may then be governed by the relative performance of the leader stocks of two categories and may imply a switch into the leader stocks of a particular category first, followed by a subsequent lead-lag effect for that category. Empirical tests using daily returns to Australian industry portfolios suggests that this model of switching involving heterogeneous stocks within a category is a more accurate representation of how switching occurs in equity markets.