A way to an improved Size and Value Factors

8.September 2015

#25 – Small Capitalization Stocks Premium Anomaly
#26 – Value (Book-to-Market) Anomaly

Authors: Lambert, Fays, Hubner

Title: Size and Value Matter, But Not the Way You Thought

Link: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2647298


Fama and French factors do not reliably estimate the size and book-to-market effects. We demonstrate inconsistent pricing of those factors in the US stock market. We replace Fama and French’s independent rankings with the conditional ones introduced by Lambert and Hübner (2013). Controlling ex-ante for noise in the estimation procedure, we have been able to highlight a much stronger book-to-market and size effects than have conventionally been documented similar to Asness et al. (2015). As a significant related outcome, the alternative risk factors have been found to deliver less specification errors when used to price investment portfolios.

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Are Size and Momentum economically significant in international stock markets

3.September 2015

#14 – Momentum Effect in Stocks
#25 – Small Capitalization Stocks Premium Anomaly

Authors: Schmidt, Von Arx, Schrimpf, Wagner, Ziegler

Title: Size and Momentum Profitability in International Stock Markets

Link: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2642185


We study the link between the profitability of momentum strategies and firm size, drawing on an extensive dataset covering 23 stock markets across the globe. We first present evidence of an “extreme” size premium in a large number of countries. These size premia, however, are most likely not realizable due to low stock market depth. We also show that international momentum profitability declines sharply with market capitalization. Momentum premiums are also considerably diminished by trading costs, when taking into account the actual portfolio turnover incurred when implementing this strategy. In contrast to strategies based on size, we find that momentum premia especially for medium-sized stocks still remain economically and statistically significant in most equity markets worldwide after adjusting for transaction costs.

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New academic paper analyses #75 – Federal Open Market Committee Meeting Effect on Stocks

27.August 2015

#75 – Federal Open Market Committee Meeting Effect on Stocks

Authors: Nilsson

Title: The Pre-FOMC Drift Explored

Link: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2640477


The pre-FOMC drift was first published in 2011 and is a strong driver of equity market performance over the last 30 years. The effect is able to explain approximately half of all the equity market returns over the measured period. We verify the results of prior studies. Furthermore, the report dives into conditional factors; equity market trend and monetary policy action to see if there is any difference in terms of macro variables. We find that FOMC is rather stable throughout time, macro conditions and has not been dependent on a particular Fed Chair.

It seems as if the markets are expecting that the FOCM will infuse optimism into equity markets as the majority of the gains occurs before the actual announcement. The effect can be due to behavioral issues and herding among market participants but can also be due to information leakage. The effect remains unexplained.

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New academic paper related to #12 – Pairs Trading with Stocks

19.August 2015

#12 – Pairs Trading with Stocks

Authors: Cartea, Jaimungal

Title: Algorithmic Trading of Co-Integrated Assets

Link: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2637883


We assume that the drift in the returns of asset prices consists of an idiosyncratic component and a common component given by a co-integration factor. We analyze the optimal investment strategy for an agent who maximizes expected utility of wealth by dynamically trading in these assets. The optimal solution is constructed explicitly in closed-form and is shown to be affine in the co-integration factor. We calibrate the model to three assets traded on the Nasdaq exchange (Google, Facebook, and Amazon) and employ simulations to showcase the strategy's performance.

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When do equity anomalies have the highest return? During earnings announcements…

11.August 2015

Authors: Engelberg, McLean, Pontiff

Title: Anomalies and News

Link: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2631228


Using a sample of 97 stock return anomalies documented in published studies, we find that anomaly returns are 7 times higher on earnings announcement days and 2 times higher on corporate news days. The effects are similar on both the long and short sides, and they survive adjustments for risk exposure and data mining. We also find that anomaly signals predict analyst forecast errors of earnings announcements. Taken together, our results support the view that anomaly returns are the result of mispricing, which is at least partially corrected upon news arrival.

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New research paper shows how to easily improve #5 – FX Carry Trade

6.August 2015

#5 – FX Carry Trade

Authors: Clare, Seaton, Smith, Thomas

Title: Carry and Trend Following Returns in the Foreign Exchange Market

Link: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2633752


Recent research has confirmed the behaviour of traders that significant excess returns can be achieved from following the predictions of the carry trade which involves buying currencies with relatively high short-term interest rates, or equivalently a high forward premium, and selling those with relatively low interest rates. This paper shows that similar-sized excess returns can be achieved by following a trend-following strategy which buys long positions in currencies that have achieved positive returns and otherwise holds cash. We demonstrate that market risk is an important determinant of carry returns but that the standard unconditional CAPM is inadequate in explaining the cross-section of forward premium ordered portfolio returns. We also show that the downside risk CAPM fails to explain this cross-section, in contrast to recent literature. A conditional CAPM which makes the impact of the market return as a risk factor depend on a measure of market liquidity performs very well in explaining more than 90% of the variation in portfolio returns and more than 90% of the average returns to the carry trade. Trend following is found to provide a significant hedge against these risks. The performance of the trend following factor is more surprising given that it does not have the negative skewness or maximum drawdown characteristic which is shown by the carry trade factor.

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