Industry regulation and the comovement of stock returns

Existing research highlights that observed levels of comovement among the returns of stocks exceed the levels predicted by theory. We develop and test the hypothesis that the degree of regulation in a particular industry can explain, at least in part, the comovement observed in the data. We find that stocks within industries that are most heavily regulated tend to exhibit the greatest levels of comovement. In a series of difference-in-differences tests, we examine comovement surrounding exogenous implementations of new regulations. Our results show that new regulatory environments for particular industries disproportionately influence the comovement of stocks in those industries.