Why commonality persists

Studies on commonality in returns, order flows and liquidity find that the first principal component is closely aligned with the market factor. With the increasing presence of high-frequency trading, commonality in returns, order flows, and liquidity can potentially arise from the commonality in the interpretation of real-time signals. In this paper, we go beyond the first factor and show that the other dominant principal components consistently reflects investors' herding behavior, demonstrating the multi-dimensional aspect of commonality. Instead of relating the asset returns to order flows, we take both as endogenous, and provide empirical evidence showing that returns commonality is driven by investors' attention, while order flows commonality is driven by investors' sentiment. We also present a comprehensive longitudinal study of commonality and co-movement over a period in excess of two decades under a unifying market microstructure framework to demonstrate the persistence of commonality over time. Our results not only extend the knowledge about cross-sectional asset behaviors, but can also be used to develop systematic trading strategies.