Investment Anomalies and Trading Strategies Flashcards
What evidence could one put forward to argue that traditional CAPM might be missing some factors?
Portfolios with the same Beta having different expected returns implies arbitrage opportunities, which may point to there being missing factors.
What two factors do Fama and French use in their most basic set-up?
- Valuation Effect measured by Price to Earnings Ratio, Cashflow measure, etc.
- Size effect.
What are the results of French and Fama in their study of the Size and Value effect? The one where they created 25 portfolios.
High-Value small cap stocks have higher sharpe ratios, alphas and excess returns. Market bettas do not vary substantially across porfolios.
What are the results of the SMB and HML CAPM Fama French Regressions?
The coefficients increase in the expected direction. Coefficients of small portfolios are indeed high for portfolios consisting of small firms, for all levels of value, and decreasing as exposure to big firms increases.
What are the serial correlation patterns of stock in the short, medium and long term?
- Short: Reversal over 1 month.
- Medium: Momentum over 12 months
- Long: Reversal over 3-5 years.
What do Fama and French find about Momentum and Long-term reversal play’s exposure to risk factors?
Long term loosers are more exposed to value and size factors which explains subsequent high performance. Nothing for momentum.
What are the diverse findings with respect to momentum stock plays’ returns? What about the risk factor exposure?
They work well out of sample and in sample. Winners are not consistently overexposed to diverse factors compared to loosers.
What are different hypothesis for the overperformance of momentum strategies.
- Mutual Funds: MF that perform well receive more inflows and continue buying the same assets.
- Spread of Buy-Sell orders: Institutional investors spread their orders to limit market influence.
- Over/under reaction
Explain the link between analyst coverage and momentum.
Lower analyst coverage implies lower speed of information diffusion, implying underreaction.
What is the correlation between value and momentum?
Negative.
Describe the Betting against Beta portfolio.
The BAB portfolio goes long low Beta stocks and shorts high Beta stocks. It delivers positive alpha, as they are usually a declining function of Beta.
What is the possible explanations for the BAB portfolio’s outperformance?
Funding Constraints increase high Beta allocation: Agents that have some financing constraints can only gain greater exposure to the market by buying high beta stocks, which artificially inflates their value and reduces expected returns.
What are the important characteristics that the Quality minus Junk portfolio assesses?
- Profitability
- Pay-out ratio
- Prior growth
- “Safety”, i.e. low required return.
What are the empirical findings when testing the Quality minus Junk Portfolio?
High quality stocks have higher returns than junk ones with less exposure to Beta, and thus deliver significant alpha.
What is one relationship between size and quality that might affect portfolio construction?
Large firms tend to be high quality and small firms low quality. So the size premium where small firms deliver more returns is partially offset by the junk small firms that we have.
