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Stock Selection, Style Rotation, and Risk

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  • André Lucas

    ()
    (Vrije Universiteit Amsterdam)

  • Ronald van Dijk

    (ING Investment Management, and Tilburg University)

  • Teun Kloek

    ()
    (Erasmus University Rotterdam, and ING Investment Management)

Abstract

Using US data from June 1984 to July 1999, we show that the impact of firm-specificcharacteristics like size and book-to-price on future excess stock returns varies considerably overtime. The impact can be either positive or negative at different times. This time variation ispartially predictable. We investigate whether the partial predictability signals security mispricing orrisk compensation by formulating alternative modeling strategies. The strategies are comparedempirically, In particular, we allow for a state-dependent choice of investment styles rather than aonce-and-for-all choice for a particular style, for example based on high book-to-price ratios orsmall market cap values. Using alternative ways to correct for risk, we find significant and robustexcess returns to style rotating investment strategies. Business cycle oriented approaches exhibitthe best overall performance. Purely statistical models for style rotation or fixed investment stylesreveal less robust behavior.

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Bibliographic Info

Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 01-021/2.

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Date of creation: 26 Feb 2001
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Handle: RePEc:dgr:uvatin:20010021

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Web page: http://www.tinbergen.nl

Related research

Keywords: investment style; time-varying parameters; risk compensation; business cycles;

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  1. Pesaran, M Hashem & Timmermann, Allan, 1995. " Predictability of Stock Returns: Robustness and Economic Significance," Journal of Finance, American Finance Association, American Finance Association, vol. 50(4), pages 1201-28, September.
  2. Schwert, G William, 1990. " Stock Returns and Real Activity: A Century of Evidence," Journal of Finance, American Finance Association, American Finance Association, vol. 45(4), pages 1237-57, September.
  3. Chen, Nai-Fu, 1991. " Financial Investment Opportunities and the Macroeconomy," Journal of Finance, American Finance Association, American Finance Association, vol. 46(2), pages 529-54, June.
  4. Andrew W. Lo & A. Craig MacKinlay, 1989. "Data-Snooping Biases in Tests of Financial Asset Pricing Models," NBER Working Papers 3001, National Bureau of Economic Research, Inc.
  5. Lakonishok, Josef & Shleifer, Andrei & Vishny, Robert W, 1994. " Contrarian Investment, Extrapolation, and Risk," Journal of Finance, American Finance Association, American Finance Association, vol. 49(5), pages 1541-78, December.
  6. Peter C.B. Phillips, 1990. "A Shortcut to LAD Estimator Asymptotics," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 949, Cowles Foundation for Research in Economics, Yale University.
  7. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 59(3), pages 383-403, July.
  8. Pesaran, M.H. & Timmermann, A., 1992. "Forecasting Stock Returns," Cambridge Working Papers in Economics, Faculty of Economics, University of Cambridge 9216, Faculty of Economics, University of Cambridge.
  9. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, Elsevier, vol. 33(1), pages 3-56, February.
  10. La Porta, Rafael, 1996. " Expectations and the Cross-Section of Stock Returns," Journal of Finance, American Finance Association, American Finance Association, vol. 51(5), pages 1715-42, December.
  11. Daniel, Kent & Titman, Sheridan, 1997. " Evidence on the Characteristics of Cross Sectional Variation in Stock Returns," Journal of Finance, American Finance Association, American Finance Association, vol. 52(1), pages 1-33, March.
  12. Rosenberg, Barr, 1974. "Extra-Market Components of Covariance in Security Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 9(02), pages 263-274, March.
  13. Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, American Finance Association, vol. 47(2), pages 427-65, June.
  14. Jensen, Gerald R. & Mercer, Jeffrey M. & Johnson, Robert R., 1996. "Business conditions, monetary policy, and expected security returns," Journal of Financial Economics, Elsevier, Elsevier, vol. 40(2), pages 213-237, February.
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Cited by:
  1. Manuel Ammann & Michael Verhofen, 2006. "The Effect of Market Regimes on Style Allocation," Financial Markets and Portfolio Management, Springer, Springer, vol. 20(3), pages 309-337, September.
  2. Chao, Hsiao-Ying & Collver, Charles & Limthanakom, Natcha, 2012. "Global style momentum," Journal of Empirical Finance, Elsevier, Elsevier, vol. 19(3), pages 319-333.
  3. Georgi Nalbantov & Rob Bauer & Ida Sprinkhuizen-Kuyper, 2006. "Equity style timing using support vector regressions," Applied Financial Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 16(15), pages 1095-1111.
  4. Bauer, Rob & Derwall, Jeroen & Molenaar, Roderick, 2004. "The real-time predictability of the size and value premium in Japan," Pacific-Basin Finance Journal, Elsevier, Elsevier, vol. 12(5), pages 503-523, November.

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