Return enhancement trading strategies for size based portfolios |
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Authors: | Glen A Larsen Jr Bruce G Resnick |
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Institution: | (1) Kelley School of Business, Indiana University, Indianapolis, IN 46202, USA;(2) Babcock Graduate School of Management, Wake Forest University, Winston-Salem, NC 27109, USA |
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Abstract: | Recent theoretical work suggests that definitions of market efficiency that allow for the possibility of time-varying risk-premia
will generally lead to return sign predictability. Consistent with this theory, we show that a logit model based on the lagged
value of the market risk premium is useful for successfully predicting the return sign for CRSP small decile portfolio returns,
but not large ones. We additionally employ this model in market timing simulations of micro-cap mutual funds in which investment
can actually be made. The results indicate that a market-timing strategy based on our return-sign forecasting model outperforms
a buy-and-hold strategy for 13 of 14 micro-cap funds studied. On average, the buy-and-hold strategy produces an average compound
return of 11.98% per annum versus an average of 16.60% for the market-timing strategy. Nevertheless, trading restrictions
make the return-sign forecasting model more practical to employ by the micro-cap fund portfolio manager rather than the individual
fund investor.
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Keywords: | Enhanced returns Trading strategies Term structure Business cycles Forecasting Portfolio choice |
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