based on the joint work with … Devraj Basu EDHEC Business School

1. based on the joint work with … • Devraj Basu • EDHEC Business School Anomaly Timing Daniel Chi-Hsiou Hung Durham Business School Durham University http://www.dur.ac.uk/d.c.hung Chi-Hsiou Hung

2. Introduction overview literature theory results extensions synopsis: objectives: • in this paper … • we construct timing strategies: • based on the lagged return on the market • time the portfolios of asset-pricing anomalies • achieve higher Sharpe ratios • with lower volatility • positive and significant model alphas • develop timing strategies … • use the state of the market as a timing signal … • use size, book-to-market and momentum portfolios as primitive assets • … investigate their performance • an upside risk factor … Chi-Hsiou Hung

3. Introduction overview literature theory results extensions Motivation: Asset-pricing anomalies • Zero net-worth portfolios which buy and sell short on equity securities with some firm-characteristics generate profits • The effect of size (market capitalization of equity) : Banz, 1981 • The effect of value (book-to-market equity ratio) : Fama and French, 1993 • The effect of momentum (past returns) : Jegadeesh and Titman (1993 and 2001) Chi-Hsiou Hung Chi-Hsiou Hung

4. Introduction overview literature theory results extensions Motivations: the returns on the anomalies portfolios and trading activities are correlated with the states of the market • momentum profits follow positive market returns(Cooper, Gutierrez and Hameed, JF, 2004 ) • momentum loses follow negative market returns (Cooper, Gutierrez and Hameed, JF, 2004) • small size stocks, value stocks, and past return losers exhibit greater correlation asymmetries with the aggregate U.S. market (Ang and Chen, JFE, 2002) • trading volume is positively related to lagged market returns (Statman, Thorley and Vorkink, RFS, 2006) Chi-Hsiou Hung Chi-Hsiou Hung

5. Introduction overview literature theory results extensions Our investigations … the state of the market may be a timing signal • We construct simple timing strategies that invest in the primitive assets of the size, book-to-market and momentum portfolios • The objectives are to capture the upside returns and avoid the downside losses on these portfolios • … the type I and type II timing strategies • These strategies are long only • … and are easy to implement Chi-Hsiou Hung Chi-Hsiou Hung

6. Introduction literature theory data results extensions Our investigations … Timing strategies: • Type I: • invest in the primitive assets in a given month if the return on the CRSP Value Weighted index in the previous month is positive • otherwise invest in the 1 month Treasury bills • Type II: • invest in the primitive assets in a given month if the return on the CRSP Value Weighted index in the previous month is greater than 2% • otherwise invest in the 1 month Treasury bills Chi-Hsiou Hung

7. Introduction literature theory data results extensions Our investigations … Evaluation of the economic and statistical significance of the returns • timing strategies outperform the primitive assets in terms of: • Higher Sharpe ratio • considerably lower volatility • use asset-pricing models : • that explain the returns on the primitive portfolios • find positive, often significant, alphas relative to these models • We augment the models with an upside factor : • which is the maximum of the market return and zero … • most of the alphas become negative • none of the positive alphas are significant • positive and significant loading on the upside factor Chi-Hsiou Hung

8. Introduction overview literature methodology results extensions What is the“type I timing strategy”? • The strategy switches in and out of the risky assets … return of the strategy the timing signal Chi-Hsiou Hung

9. Introduction overview literature methodology results extensions What is the“type II timing strategy”? • The strategy switches in and out of the risky assets … return of the strategy the timing signal Chi-Hsiou Hung Chi-Hsiou Hung

10. Introduction overview literature theory empirical tests extensions Data • We use all monthly equity data of the NYSE, AMEX and NASDAQ files from the Center for Research in Security Price (CRSP) between January 1926 and December 2006. Chi-Hsiou Hung

11. Introduction overview literature theory empirical tests extensions Primitive assets • two sets of equally weighted portfolios: • The top and bottom decile portfolios • Stock portfolios of the top and bottom 30% of the sorting criteria • momentum winner and loser portfolios (returns over months t-2 to t-12) • book-to-market ratio (value) portfolios • equity market capital (size) portfolios • long-term winner and loser portfolios (reversal): returns over months t-13 to t-60 Chi-Hsiou Hung

12. Introduction overview literature theory analysis extensions risk and return profiles of the primitive portfolios Chi-Hsiou Hung

13. Introduction overview literature theory results extensions risk and return profiles of the type I strategies Chi-Hsiou Hung

14. Introduction overview literature theory results extensions risk and return profiles of the type I strategies • All the average returns of the strategies are positive • The Bonferroni adjusted probabilities for observing the p-values are all highly significant • the type I strategies based on for all primitive assets but the winner portfolios improve the risk adjusted performance (Sharpe ratio) Chi-Hsiou Hung

15. Introduction overview literature theory results extensions risk and return profiles of the type II strategies Chi-Hsiou Hung

16. Introduction overview literature theory results extensions risk and return profiles of the type II strategies • the type II strategies further improve the risk reward profiles for all but the strategy based on the loser portfolios • The type II timing strategies considerably reduce both total volatility and downside volatility Chi-Hsiou Hung

17. Introduction overview literature theory results extensions Extreme up and down moves ratios • Extreme up moves: • a monthly gain of more than 5% • Extreme down moves: • a monthly loss of more than 5% • We compute the ratio of extreme up (down) moves of a timing strategy to that of the primitive portfolio: • A high ratio of extreme up moves indicates the ability of the strategy in capturing the extreme upside returns of the primitive portfolio … • A low ratio of extreme down moves indicates that the strategy avoids much of the extreme downside losses

18. Introduction overview literature theory results extensions Extreme up and down moves ratios

19. Introduction overview literature theory results extensions Extreme up and down moves ratios • the type I strategies: • capture between 57% and 79% of the extreme up moves of the primitive assets, • reduce the extreme down moves to between 38% and 59% • the type II strategies: • capture between 37% and 57% of the extreme up moves • reduce the extreme down moves to between 10% and 33%

20. Introduction overview literature theory analysis extensions Evaluation using unconditional asset-pricing models: • an unconditional K-factor model… the MKT, SMB, HML and UMD plus an upside market factor

21. Introduction overview literature theory results extensions Evaluation using asset-pricing models

22. Introduction overview literature theory results extensions Evaluation using unconditional pricing models for type I:

23. Introduction overview literature theory results extensions Evaluation using unconditional pricing models for type II:

24. Introduction overview literature theory analysis extensions Evaluation using conditional asset-pricing models: • a conditional K-factor model… the MKT, SMB, HML and UMD plus a dummy variable Instruments of 1 month T-bill rate, the term spread and the default spread

25. Introduction overview literature theory results extensions Evaluation using conditional pricing models for type I:

26. Introduction overview literature theory results extensions Evaluation using conditional pricing models for type II:

27. Introduction overview literature theory results conclusions Conclusions • Simple timing strategies successfully capture the upside returns on the size, book-to-market and momentum portfolios • and avoid their downside losses • They remain profitable after accounting for relatively high levels of transaction costs • the variation in returns on the timing strategies is better explained by dynamic factor betas Chi-Hsiou Hung