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Conditional Style Rotation Model on Enhanced Value and Growth Portfolios: The European Experience

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Academic and professional attention has been devoted in the past to the analysis of the potential value-enhancement generated by strategies based on macroeconomic models and applied to portfolios or indexes of style classes. In this paper, we analyse the extent of the excess returns that can be potentially generated by rotating a portfolio between value and growth stocks in the European markets. We extend the results obtained by Bird and Casavecchia (Bird, R. and Casavecchia. L. (2007) Sentiment and financial health indicators for value and growth stocks: the European experience, European Journal of Finance, 13, pp. 769-793) when applying market sentiment and financial health indicators to stocks and document the extent to which macroeconomic factors convey information that is not already impounded in these indicators. We find that a strategy to rotate between portfolios, constructed on either single valuation metrics or their enhancement by market sentiment and a company’s financial strength, is typically consistent, monotonic, and in the expected direction. This highlights the proposition that the macroeconomic factors capture a cross-sectional variation that is not typically impounded in unconditional regression models on value and growth portfolios.

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Paper provided by The Paul Woolley Centre for Capital Market Dysfunctionality, University of Technology, Sydney in its series Working Paper Series with number 2.

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Length: 24 pages
Date of creation: 01 May 2008
Date of revision:
Handle: RePEc:uts:pwcwps:2

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Keywords: style rotation; financial health; market sentiment; asset pricing anomalies;

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  1. Wayne E. Ferson & Campbell R. Harvey, 1999. "Conditioning Variables and the Cross-Section of Stock Returns," NBER Working Papers 7009, National Bureau of Economic Research, Inc.
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  4. Biorn,E., 2001. "How is generalized least squares related to within and between estimators in unbalanced panel data?," Memorandum, Oslo University, Department of Economics 06/2001, Oslo University, Department of Economics.
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  7. Ron Bird & Lorenzo Casavecchia, 2007. "Sentiment and Financial Health Indicators for Value and Growth Stocks: The European Experience," The European Journal of Finance, Taylor & Francis Journals, Taylor & Francis Journals, vol. 13(8), pages 769-793.
  8. Campbell, John Y., 1987. "Stock returns and the term structure," Journal of Financial Economics, Elsevier, Elsevier, vol. 18(2), pages 373-399, June.
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  10. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, Elsevier, vol. 25(1), pages 23-49, November.
  11. Elton, Edwin J & Gruber, Martin J & Blake, Christopher R, 1995. " Fundamental Economic Variables, Expected Returns, and Bond Fund Performance," Journal of Finance, American Finance Association, American Finance Association, vol. 50(4), pages 1229-56, September.
  12. Conrad, Jennifer & Kaul, Gautam, 1993. " Long-Term Market Overreaction or Biases in Computed Returns?," Journal of Finance, American Finance Association, American Finance Association, vol. 48(1), pages 39-63, March.
  13. Fama, Eugene F. & Gibbons, Michael R., 1984. "A comparison of inflation forecasts," Journal of Monetary Economics, Elsevier, Elsevier, vol. 13(3), pages 327-348, May.
  14. Fama, Eugene F & French, Kenneth R, 1996. " Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, American Finance Association, vol. 51(1), pages 55-84, March.
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