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Skewness Underlies Stock Market Anomalies?

Does retail investor preference for stocks with skewed return distributions explain stock return anomalies? In their April 2018 paper entitled “Skewness Preference and Market Anomalies”, Alok Kumar, Mehrshad Motahari and Richard Taffler investigate whether investor preference for positively-skewed payoffs is a common driver of mispricing as indicated by a wide range of market anomalies. They each month measure the skewness of each stock via four metrics: (1) jackpot probability (probability of a return greater than 100% the next 12 months); (2) lottery index (with high relating to low price, high volatility and high skewness; (3) maximum daily return the past month; and, (4) expected idiosyncratic skewness. They also each month measure aggregate mispricing of each stock as its average decile rank when sorting all stocks into tenths on each of 11 widely used anomaly variables. They assess the role of retail investors based on 1991-1996 portfolio holdings data from a large U.S. discount broker. Using a broad sample of U.S. common stocks (excluding financial stocks, firms with negative book value and stocks priced less than $1) during January 1963 through December 2015, they find that: Keep Reading

Momentum Strategy, Value Strategy and Trading Calendar Updates

We have updated monthly Simple Asset Class ETF Momentum Strategy (SACEMS) winners and associated performance data at “Momentum Strategy”. We have updated monthly Simple Asset Class ETF Value Strategy (SACEVS) allocations and associated performance data at “Value Strategy”. We have also updated performance data for the “Combined Value-Momentum Strategy”.

We have updated the “Trading Calendar” to incorporate data for May 2018.

Preliminary Momentum Strategy and Value Strategy Updates

The home page“Momentum Strategy” and “Value Strategy” now show preliminary Simple Asset Class ETF Momentum Strategy (SACEMS) and Simple Asset Class ETF Value Strategy (SACEVS) positions for June 2018. For SACEMS, the top three positions are unlikely to change by the close. For SACEVS, allocations are very unlikely to change by the close.

Stock Market Continuation and Reversal Months?

Are some calendar months more likely to exhibit stock market continuation or reversal than others, perhaps due to seasonal or fund reporting effects? In other words, is intrinsic (times series or absolute) momentum an artifact of some months or all months? To investigate, we relate U.S. stock index returns for each calendar month to those for the preceding 3, 6 and 12 months. Using monthly closes of the S&P 500 Index since December 1949 (using the January 1950 open) and the Russell 2000 Index since September 1987, both through April 2018, we find that: Keep Reading

SACEVS and SACEMS from a European Perspective

A European subscriber asked about the effect of the dollar-euro exchange rate on the Simple Asset Class ETF Value Strategy (SACEVS) and the Simple Asset Class ETF Momentum Strategy (SACEMS). To investigate, we each month adjust the gross returns for these strategies for the change in the dollar-euro exchange rate that month. We consider all strategy variations: Best Value and Weighted for SACEVS; and, Top 1, equally weighted (EW) Top 2 and EW Top 3 for SACEVS. We focus on SACEVS Best Value and SACEMS EW Top 3. We consider effects on four gross performance metrics: average monthly return; standard deviation of monthly returns; compound annual growth rate (CAGR); and, maximum drawdown (MaxDD). Using monthly returns for the strategies and monthly changes in the dollar-euro exchange rate since August 2002 for SACEVS and since August 2006 for SACEMS, both through April 2018, we find that: Keep Reading

Sifting the Factor Zoo

The body of U.S. stock market research offers hundreds of factors (the factor zoo) to explain and predict return differences across stocks. Is there a reduced set of factors that most accurately and consistently captures fundamental equity risks? In their March 2018 paper entitled “Searching the Factor Zoo”, Soosung Hwang and Alexandre Rubesam employ Bayesian inference to test all possible multi-factor linear models of stock returns and identify the best models. This approach enables testing of thousands of individual assets in combination with hundreds of candidate factors. They consider a universe of 83 candidate factors: the market return in excess of the risk-free rate, plus 82 factors measured as the difference in value-weighted average returns between extreme tenths (deciles) of stocks sorted on stock/firm characteristics. Their stock universe consists of all U.S. listed stocks excluding financial stocks, stocks with market capitalizations less than the NYSE 20th percentile (microcaps) and stocks priced less than $1. They test microcaps separately. They further test 20 sets of test portfolios (300 total portfolios). The overall sample period is January 1980 through December 2016. To assess factor model performance consistency, they break this sample period into three or five equal subperiods. Using the specified data as available over the 36-year sample period, they find that: Keep Reading

Weekly Summary of Research Findings: 5/21/18 – 5/25/18

Below is a weekly summary of our research findings for 5/21/18 through 5/25/18. These summaries give you a quick snapshot of our content the past week so that you can quickly decide what’s relevant to your investing needs.

Subscribers: To receive these weekly digests via email, click here to sign up for our mailing list. Keep Reading

Revisiting VIX as Stock Return Predictor

Does implied stock market volatility (IV) predict stock market returns? In their March 2018 paper entitled “Implied Volatility Measures As Indicators of Future Market Returns”, Roberto Bandelli and Wenye Wang analyze the relationship between S&P 500 Index IV and future S&P 500 Index returns. They consider volatilities implied either by S&P 500 Index options (VIX) or by 30-day at-the-money S&P 500 Index straddles. Specifically, they each day:

  1. Rank current S&P 500 Index IV according to ranked tenth (decile) of its daily distribution over the past two years. If current IV is higher than any value of IV over the past two years, its rank is 11.
  2. Calculate S&P 500 Index returns over the next one, five and 20 trading days.
  3. Relate these returns to IV rank.

They calculate statistical significance based on the difference between the average IV-ranked log returns and log returns over all intervals of the same length. Using daily data for the selected variables during December 1991 through November 2017, they find that: Keep Reading

Testing a Countercyclical Asset Allocation Strategy

“Countercyclical Asset Allocation Strategy” summarizes research on a simple countercyclical asset allocation strategy that systematically raises (lowers) the allocation to an asset class when its current aggregate allocation is relatively low (high). The underlying research is not specific on calculating portfolio allocations and returns. To corroborate findings, we use annual mutual fund and exchange-traded fund (ETF) allocations to stocks and bonds worldwide from the 2018 Investment Company Fact Book, Data Tables 3 and 11 to determine annual countercyclical allocations for stocks and bonds (ignoring allocations to money market funds). Specifically:

  • If actual aggregate mutual fund/ETF allocation to stocks in a given year is above (below) 60%, we set next-year portfolio allocation below (above) 60% by the same percentage.
  • If actual aggregate mutual fund/ETF allocation to bonds in a given year is above (below) 40%, we set next-year portfolio allocation below (above) 40% by the same percentage.

We then apply next-year allocations to stock (Fidelity Fund, FFIDX) and bond (Fidelity Investment Grade Bond Fund, FBNDX) mutual funds that have long histories. Based on Fact Book annual publication dates, we rebalance at the end of April each year. Using the specified actual fund allocations for 1984 through 2017 and FFIDX and FBNDX May through April total returns and April 1-year U.S. Treasury note (T-note) yields for 1985 through 2018, we find that: Keep Reading

Intrinsic (Time Series) Momentum Does Not Really Exist?

Does rigorous re-examination of time series (intrinsic or absolute) asset return momentum confirm its statistical and economic significance? In their April 2018 paper entitled “Time-Series Momentum: Is it There?”, Dashan Huang, Jiangyuan Li, Liyao Wang and Guofu Zhou conduct a three-stage review of evidence for predictability of next-month returns based on past 12-month returns for a broad set of asset futures/forwards:

  1. They first run a time series regression of monthly returns versus past 12-month returns for each asset to check predictability for individual assets.
  2. They then run pooled time series regressions for asset returns scaled by respective volatilities as done in prior research, overall and by asset class, noting that pooled regressions can inflate conventional t-statistics and thereby incorrectly reject the null hypothesis. To correct for this predictability inflation, they apply three kinds of bootstrapping simulations.
  3. Finally, they consider a simple alternative explanation of the profitability of an intrinsic momentum strategy tested in prior research that each month buys (sells) assets with positive (negative) past 12-month returns, with the portfolio weight for each asset 40% divided by its past annualized volatility (asset-level target volatility 40%).

Their asset sample consists of 55 contract series spanning commodity futures (24), equity index futures (9), government bond futures (13) and currency forwards (9). They construct returns for an asset by each day calculating excess return for the nearest or next-nearest contract and compounding to compute monthly excess return. Using daily excess returns for the 55 contract series during January 1985 through December 2015, they find that: Keep Reading

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