Excess Returns Research Articles

The prescriptive nature of market timing and predictive portfolios

Abstract We explore the ability of market timing, model-based forecasts that include incremental information over and above momentum, to create long-short portfolios that consistently provide superior returns to traditional benchmarks, and frame our analysis in the idea of “prediction-led prescription” for forward-looking decision making. Our methodology consists of linear and non-linear forecasts with model selection, that predict the direction of future returns and apply then into the construction of portfolios. Our results strongly recommend that predictive-based portfolio allocation can produce excess returns and higher Sharpe ratios, above and beyond the individual return series that are utilized to create the forecasts and traditional portfolio benchmarks. The use of “predictive methods in portfolio construction reinforces the idea of prediction-led prescription” as portfolios are prescriptions for investment management and have an exclusively forward-looking nature.

The Memory in Return Volatility: An Analysis of Mutual Fund Returns

ABSTRACTThis paper examines long memory in the return volatility in the cross‐section of U.S. mutual funds. Our results provide evidence of this phenomenon. Through univariate analysis, we find that the long memory in mutual fund return volatility is more pronounced than in stock return volatility. Additionally, the long memory estimate is negatively related to expected fund returns. Holding a long position in shorter‐term memory funds and a short position in longer‐term memory funds generates significant excess returns of 0.26% per month for value‐weighted portfolios.

Investigation on Influence Factors of the C-REIT Market: Applying the Fama-French Three-Factor Model

This research paper has applied the Fama-French Three-Factor Model to the China Real Estate Investment Trust (C-REIT) market over a two-year period from June 2022 to June 2024. The innovation is recognized as the C-REIT market was established in 2021 with the first 9 REITs issued and few researches were conducted on the C-REITs. The study obtained data from the Wind database in the after-COVID period and concluded that the model fits well for the behavior of the Chinese REIT market. The market premium factor is found to be positive, while the size factor (SMB) is negatively significant, and the value premium (HML) is positively significant. This suggests that REITs with smaller market capitalization and those with a higher book-to-market ratio are more likely to contribute to the portfolio's excess returns. The intercept in the regression is statistically significant and that implies that there may be additional factors that are not captured by the current model. As such, the paper advocates for further research into multi-factor models to explore potential factors.

Is the Chinese stock market efficient? Evidence from a combined liquidity trading strategy

PurposeThis study examines the stock market efficiency in China to offer trading strategy guidance to investors and efficiency evaluation insight to policymakers.Design/methodology/approachThis study examines the stock market efficiency in China with a new combined liquidity trading strategy by blending technical analysis into a liquidity buy-and-hold strategy.FindingsOur results show that the combined strategy generates significant excess returns in the whole sample period, suggesting that the Chinese stock market is not consistent with the weak form efficient hypothesis. In addition, the combined strategy yields more significant risk-adjusted excess returns after the 2004 split-share reform, indicating the stock market efficiency in China does not exhibit a distinct upgrade after the reform. Our further test results reinforce the main conclusions after taking transaction costs, market states, short-selling reform and other issues into consideration.Originality/valueOur study contributes to the literature in two ways: First, we shed light on the mixed documented results about the market efficiency form in China. Second, we contribute to the mixed relation between the 2004 split-share reform and market efficiency in China.

Can Outsiders Often See the Most? Evidence from China: The Impact of Foreign Investors on Insider Trading

ABSTRACT Insiders could exploit their informational advantage to obtain excessive returns. Based on the quasi-natural experiment of the Shanghai-Hong Kong and Shenzhen-Hong Kong Stock Connect trading systems, we examine the inhibitory impact of foreign investors on insiders’ informational advantage. Our findings indicate that the advent of the Stock Connect trading system has diminished the profitability of insider trading for the target companies. The influence operates through two primary channels: the information effect and the liquidity effect. Specifically, the Stock Connect trading system has hindered insiders’ stock buying and their profitability by reducing stock price synchronicity. Besides, it facilitates an increase in insiders’ stock selling by addressing liquidity shortages. Further tests demonstrate that those insiders with obvious informational advantage and great power are obviously impacted by the inhibition effect on their profitability. Our results show that the exploration of investment opportunities by foreign investors has reduced the insiders’ ability to profit from increasing their shareholdings. Additionally, it offers liquidity support for insiders, enabling them to decrease their shareholdings. These promote fair trading and the efficient functioning of the capital market.

Decomposing Uncertainty: How Foreign Policy Risks Shape Chinese Stock Market Dynamics

This study examines the transmission mechanism of foreign economic policy uncertainty (FEPU) on the Chinese stock market from 1997 to 2022, using a vector autoregressive adaptation of the dividend discount model. By decomposing excess returns into cash flow (CF), excess return (ER), and risk-free rate (RF) components, we disentangle the effects of FEPU shocks on these distinct factors.Our findings indicate that FEPU primarily leads to a significant but temporary overestimation of impacts on cash flows and excess returns, with the market typically correcting itself after an initial overreaction. This pattern suggests a complex interplay between investor sentiment and market dynamics. Notably, trade stability amplifies the impact on CF, while closer monetary policy coordination enhances the transmission to RF and ER expectations. Additionally, economic cycles play a moderating role: downturns exacerbate the negative impacts on CF and RF, while bullish conditions foster resilience. Investor sentiment emerges as a crucial factor, with negative sentiment intensifying FEPU’s adverse effects during economic contractions.This research contributes a detailed perspective on how international relations, policy harmonization, and market psychology collectively influence FEPU transmission and affect China’s financial stability amidst global uncertainties. Our decomposition method illuminates the dynamic forces that drive market reactions over time, offering critical insights for refining risk management strategies and crafting policy measures that buffer the financial system against external economic shocks.

Dynamically adjusted cross-currency carry strategy

We examine time-varying excess return in a dynamically adjusted international “cross-currency” carry strategy, with a focus on excess returns. Unlike traditional carriers that fund and invest in bonds with the same maturities, the novel dynamic strategy involves funding with a 1-year low-yield treasury bond and investing in 2- to 10-year high-yield bonds in other currencies. An analysis of Sharpe ratios, foreign exchange (FX), and yield excess return shows variations in the joint expectation hypotheses expectations hypothesis of the term structure (EHTS) and the uncovered interest rate parity (UIRP) lead to profits. However, the international strategies perform worse than the domestic carry strategies. Predictive factors, such as the Cochrane–Piazzesi, show limited effectiveness due to FX volatility. Therefore, future studies should examine more predictability factors.

Economic policy uncertainty in OFDI host countries and the cross-section of stock returns

This study examines the association between foreign economic policy uncertainty (FEPU) originating from the host countries (regions) of outward foreign direct investment (OFDI) and expected stock returns. We construct a novel variable, FEPU, based on the year-end OFDI amounts of Chinese listed multinational enterprises (MNEs) and the EPU indices of 23 host countries (regions). Our findings reveal that stocks with higher FEPU outperform those with lower FEPU by 4.96 % annually. Beyond predicting short-term expected returns, FEPU also exhibits strong positive predictive power for firms’ long-term cumulative returns. Additionally, through mechanism tests, we demonstrate that this excess return is attributable to compensation for risk premium. Unlike the majority of studies that focus solely on the impact of EPU within a single country or region, we examine the cross-border implications of EPU. This approach offers an innovative perspective on the pricing of MNEs’ stocks by characterizing the exposure to external EPU.

A two-step method for assessing enhanced value in turnaround, spin-off, and value stocks

To assess outright and relative value opportunities in stocks and benchmark their performance against an index with global relevance, it is important to achieve and measure risk-adjusted excess returns. Academic and corporate research has focused quite extensively on analyzing stock returns and comparing the outperformance of specific investment strategies, with value investing being one of the most prominent and longest-known factor strategies. In this event study, to test for the existence of risk-adjusted excess returns, or alpha, a novel two-step approach is proposed to assess Enhanced Value in single stocks for three different investment approaches: plain value investing, investing in spin-offs, and investing in turnaround companies. While the first step of the two-step approach screens companies for a combination of financial company characteristics, the second step ranks and sorts them by either their price-earnings ratio or by their price-book ratio, thus “enhancing” the value assessment. Their short- and mid-term stock performance is investigated for an investment horizon of one year, three years, and five years. Stocks of value companies, spin-offs, and turnaround companies outperform the S&P 500 benchmark on average and on a risk-adjusted basis for all three investment horizons when tested for Enhanced Value with the novel two-step approach. The analysis results provide deeper insights into how the value factor in its different characteristics needs to be understood in the context of investment strategies and how it potentially can be applied to stock selection and portfolio construction, resulting in investment strategies showing a risk-adjusted outperformance.

Duration-Based Valuation of Corporate Bonds

Abstract We decompose corporate bond and equity index returns into duration-matched government bond returns and the excess returns over this duration-matched counterfactual, which we term duration-adjusted returns. Compared with previously used excess return definitions (ie, returns in excess of Treasury bills), our decomposition leads to markedly different return patterns and asset pricing implications. In particular, we find that investment-grade bonds earn a small credit risk premium, comparable in magnitude to the convenience yield, and that duration adjustment resolves the CAPM’s failure to price corporate bonds. These findings highlight the importance of adjusting for nonstationary interest rate environments in asset pricing tests. (JEL G10, G12)

Excess Returns Unleashed: Dynamic Momentum-Contrarian Strategy with Ichimoku

Excess Returns Unleashed: Dynamic Momentum-Contrarian Strategy with Ichimoku

Anti-Persistent Values of the Hurst Exponent Anticipate Mean Reversion in Pairs Trading: The Cryptocurrencies Market as a Case Study

Pairs trading is a short-term speculation trading strategy based on matching a long position with a short position in two assets in the hope that their prices will return to their historical equilibrium. In this paper, we focus on identifying opportunities where mean reversion will happen quickly, as the commission costs associated with keeping the positions open for an extended period of time can eliminate excess returns. To this end, we propose the use of the local Hurst exponent as a signal to open trades in the cryptocurrencies market. We conduct a natural experiment to show that the spread of pairs with anti-persistent values of Hurst revert to their mean significantly faster. Next, we verify that this effect is universal across pairs with different levels of co-movement. Finally, we back-test several pairs trading strategies that include H<0.5 as an indicator and check that all of them result in profits. Hence, we conclude that the Hurst exponent represents a meaningful indicator to detect pairs trading opportunities in the cryptocurrencies market.

The Failure of Silicon Valley Bank: A Test of Market Efficiency

The unexpected collapse of Silicon Valley Bank (SVB) on March 10, 2023, sent shockwaves through the tech industry. SVB, a long-standing financial institution serving tech startups for nearly four decades, suddenly shifted from solvency to insolvency within 48 hours, marking the second-largest bank failure in U.S. history. This event provides an excellent opportunity to test the Efficient Market Hypothesis (EMH), particularly its semi-strong form, which posits that rapid information absorption prevents significant stock price gains in response to new information. This research uses the standard event study methodology in the finance literature to investigate SVB’s collapse and its impact on the stock prices of 30 banks traded on the New York Stock Exchange. The study aims to discern whether stock returns exhibited reactions prior to, on, or after the public announcement of SVB’s failure, thereby assessing market efficiency. Using historical stock and S&P 500 index data, the study analyzes holding period returns, performs regression analyses for pre-event periods, and calculates average excess returns. Results indicate statistically significant negative impacts on stock prices surrounding and on the event date. Furthermore, consistent with behavioral finance theory, a decline in adjusted stock prices approximately 7 days before the event suggests anticipatory market behavior, in line with semi-strong market efficiency. SVB’s case emphasizes the role of external factors, regulatory changes, and industry concentrations in shaping market responses. This research contributes empirical evidence to the discourse on market efficiency, highlighting the need for a nuanced understanding of market behaviors during crises. Lessons from SVB’s collapse will inform regulatory and risk management strategies, impacting future discussions on market efficiency. Likewise, the study results support the semi-strong form efficient market hypothesis and suggest the possibility of trading on this information up to 7 days prior to the announcement consistent with the behavioral finance literature (Bacon & Howell 2021). This study provides valuable insights into market dynamics during unprecedented events, influencing future discussions on regulation, risk management, and market efficiency.

From text to treasure: the predictive superiority of a FinTech index in stock market returns

This study employs a text analysis methodology to construct a Financial Technology (FinTech) Index, utilizing textual data from The New York Times. The primary aim is to investigate the correlation between financial technology and stock market performance. Our findings provide compelling evidence that the FinTech Index possesses substantial predictive capability for excess returns in the US stock market, a feature that becomes particularly pronounced during economic downturns. Notably, when compared with traditional macroeconomic indicators, the FinTech Index offers valuable incremental insights. Moreover, this study expands to include sector-level and international market analyses, demonstrating the broad applicability and robust performance of the FinTech Index. Importantly, through the use of out-of-sample testing, we substantiate that the FinTech Index demonstrates superior predictive accuracy, presenting opportunities for investors to achieve higher economic returns.

War discourse and global equity returns

This study investigates the asset pricing implications of war risks in global stock markets. We employ a novel war discourse index developed by Hirshleifer et al. (2023a), which captures market attention to war through news. Extending this approach to both developed and emerging markets, we uncover a significantly positive relation between war risks and global stock market excess returns, which is robust to a range of sensitivity checks. Our findings indicate that investor attention to war risks significantly influences equity premium in global markets.

A new economic policy uncertainty index for Brazil

This study has created a novel economic policy uncertainty (EPU) index for Brazil by analyzing the frequency of news articles published by the country’s major news portals. The measurement proposed here is based on news from different news outlets, unlike the similar index previously available, extracted by a web-scraping procedure. This research also evaluated the role of EPU in its relationship with stock returns in the Brazilian market, comparing the new index with the one previously available. The new measure showed a negative relationship with the return in excess of the risk-free rate, similar to that found using the previously existing index, but with a greater magnitude. Furthermore, the explanatory power of the regression model is substantially greater when the proposed measure is used. In this way, the study contributes not only by deepening the understanding of the relationship between uncertainty and stock returns but also by serving as a methodological subsidy for future research focusing on EPU in the country.

Is the Fama French model robust in the Chinese stock market?

Many previous studies have analyzed the different stock return models in various segments of the Chinese stock market. This essay analyzes the Fama-French five factors and three factors model in the main board, the second board, and STAR market. It finds that the three-factor models are efficient in all three markets expect for the STAR market, while the five-factor model is inefficient in testing the second board market alone and overall efficient in testing the mixed market and the STAR market. Furthermore, it is also found that the MKT factors are the most significant contributors to the portfolio excess return in all six situations. The HML and SML factors also exhibit constant relations with the portfolio return. Besides, it is found that HML and SMB factors are not significantly correlated with the stock’s performance on the STAR market. Overall, the relative efficiency of Fama French's three and five-factor model in explaining these markets is proved. Investors can use these two models to analyze the stock return and earn profit in the next period, and policymakers can also employ this model to understand the market and decide suitable fiscal and monetary policies.

Does Short Selling Regulate Insider Trading?

This study investigates the impact of short selling on the relationship between the insider net buying ratio and excess returns, as well as on insider selling volume. The research period is divided into three distinct phases: short selling allowed, short selling banned, and partial short selling. The two primary findings of the analysis are as follows. First, the profitability of insider trading, assessed through the relationship between the insider net buying ratio and excess returns, is impacted positively when short selling is banned and negatively when it is permitted. Second, the insider selling volume significantly increases following short selling bans and decreases when the same is allowed. These results suggest that short sellers function as a market discipline mechanism, regulating both the profitability and volume of insider trading. This indicates that short selling regulations wield a substantial influence on the behavior and profitability of insider trading.

Consumer confidence and cryptocurrency excess returns: A three-factor model

This study examined the relation between consumer confidence and cryptocurrency excess returns using a three-factor model of market, size and momentum. We analysed a dataset comprising 3318 cryptocurrencies from 1 January 2014 to 31 December 2022 based on the CoinMarketCap website. Results indicate a significant negative relation between the United States Consumer Confidence Index and cryptocurrency excess returns. The findings were reinforced based on robustness tests. This study contributes to consumer behaviour research and financial management within the cryptocurrency market. It also provides valuable insights for investors to strengthen their investment portfolios and for relevant authorities seeking to formulate effective policies for monitoring the cryptocurrency market.

Investigate The Influence Of The Fama and French Five-Factor Model On The SRI-KEHATI Stock Index

The capital market functions as an intermediary for the flow of funds between investors and companies, in accordance with the general principle that the greater the risk, the greater the potential profit. In estimating returns, there are several methods, one of which is the Fama French five factor model which was developed from the CAPM, APT and Fama French three factor models. This research aims to evaluate the relationship between the five-factor Fama French model and excess returns on the SRI-KEHATI stock index from 2015 - 2022. This research method adopts quantitative analysis with an associative causality approach and uses a purposive sampling technique to select 9 companies as samples. Data analysis used by Eviews 12. Study findings show that market factors have a significant influence on excess returns, while size, value, profitability and investment factors are not significant on excess returns. Overall, the Fama-French model's five factors collectively influence excess returns. This finding confirms that market conditions will influence the excess returns obtained by investors.