Stock-Selection Modeling and Data Mining Corrections: Long-Only Versus 130/30 Models

This study addresses several aspects of stock selection, portfolio construction, and data mining corrections and hypothesis testing of excess returns. Mean-variance, equally actively weighted, tracking-error-at-risk, and 130/30 portfolios are created and tests are conducted to find out whether the excess returns of these portfolios are statistically different from the average models that could have been used to build portfolios. Knowledge of earnings forecasts is an important input to the portfolio construction process. The portfolios constructed fulfill a global growthmandate, and the strategies work in EAFE plus Canada and the U.S. universes. The excess returns produced by the models are statically different from the average models used. The 130/30 strategy dominates the long-only strategy. Moreover, evidence is presented to show that these portfolios can be implemented and produce excess returns in the world of business.

[1]  Wayne H. Wagner,et al.  South African Divestment: The Investment Issues , 1984 .

[2]  E. Fama,et al.  The Cross‐Section of Expected Stock Returns , 1992 .

[3]  Phoebus J. Dhrymes,et al.  A Critical Reexamination of the Empirical Evidence on the Arbitrage Pricing Theory , 1984 .

[4]  Michael C. Jensen,et al.  Studies in the Theory of Capital Markets. , 1973 .

[5]  Josef Lakonishok,et al.  The Profitability of Momentum Strategies , 1999 .

[6]  Gregory Connor,et al.  Risk and Return in an Equilibrium Apt: Application of a New Test Methodology , 1988 .

[7]  H. Russell Fogler,et al.  Three Factors, Interest Rate Differentials and Stock Groups , 1981 .

[8]  Ganlin Xu,et al.  A Comparison of Some Aspects of the U.S. and Japanese Equity Markets , 1991, Handbook of Applied Investment Research.

[9]  Harry M. Markowitz.  The “two beta” trap , 1984 .

[10]  Wayne E. Ferson,et al.  Sources of Predictability in Portfolio Returns , 1991 .

[11]  Phoebus J. Dhrymes,et al.  New Tests of the APT and Their Implications , 1985 .

[12]  W. Sharpe,et al.  Mean-Variance Analysis in Portfolio Choice and Capital Markets , 1987 .

[13]  E. Fama,et al.  Risk, Return, and Equilibrium: Empirical Tests , 1973, Journal of Political Economy.

[14]  Andrew Rudd,et al.  The “Market Model” In Investment Management , 1980 .

[15]  R. Haugen.  Modern investment theory , 1986 .

[16]  A. Lo,et al.  What Happened to the Quants in August 2007? , 2007 .

[17]  Makoto Takano,et al.  The development of efficient portfolios in Japan with particular emphasis on sales and earnings forecasting , 1993, Ann. Oper. Res..

[18]  Barr Rosenberg,et al.  Extra-Market Components of Covariance in Security Returns , 1974, Journal of Financial and Quantitative Analysis.

[19]  Robert D. Arnott,et al.  The use and misuse of consensus earnings* , 1985 .

[20]  S. Basu.  The relationship between earnings' yield, market value and return for NYSE common stocks: Further evidence , 1983 .

[21]  Benjamin Graham,et al.  Security Analysis: Principles and Technique , 1934 .

[22]  Harry M. Markowitz,et al.  Trimability and Fast Optimization of Long–Short Portfolios , 2006 .

[23]  B. Stone.  A Linear Programming Formulation of the General Portfolio Selection Problem , 1973, Journal of Financial and Quantitative Analysis.

[24]  Balder Von Hohenbalken,et al.  A finite algorithm to maximize certain pseudoconcave functions on polytopes , 1975, Math. Program..

[25]  A. Stuart,et al.  Portfolio Selection: Efficient Diversification of Investments , 1959 .

[26]  Roger G. Clarke,et al.  Toward More Information-Efficient Portfolios , 2004 .

[27]  Bernell K. Stone,et al.  Risk, return, and equilibrium : a general single-period theory of asset selection and capital-market equilibrium , 1972 .

[28]  Campbell R. Harvey,et al.  The Variation of Economic Risk Premiums , 1990, Journal of Political Economy.

[29]  Gregory Connor,et al.  A Test for the Number of Factors in an Approximate Factor Model , 1993 .

[30]  S. Ross,et al.  Economic Forces and the Stock Market , 1986 .

[31]  Edwin J. Elton,et al.  Homogeneous Groups and the Testing of Economic Hypotheses , 1970, Journal of Financial and Quantitative Analysis.

[32]  Edwin J. Elton,et al.  Fundamental Economic Variables, Expected Returns, and Bond Fund Performance , 1995 .

[33]  D. E. Fischer,et al.  Security Analysis and Portfolio Management , 1975 .

[34]  E. Elton,et al.  ESTIMATING THE DEPENDENCE STRUCTURE OF SHARE PRICES —IMPLICATIONS FOR PORTFOLIO SELECTION , 1973 .

[35]  H. Markowitz,et al.  Data Mining Corrections , 1994 .

[36]  W. Sharpe.  CAPITAL ASSET PRICES: A THEORY OF MARKET EQUILIBRIUM UNDER CONDITIONS OF RISK* , 1964 .

[37]  S. Basu,et al.  Investment Performance of Common Stocks in Relation to their Price-Earnings Ratios , 1977 .

[38]  Steven Thorley,et al.  Portfolio Constraints and the Fundamental Law of Active Management , 2001 .

[39]  Stephen J. Brown.  Elusive Return Predictability: Discussion , 2007 .

[40]  B. King.  Market and Industry Factors in Stock Price Behavior , 1966 .

[41]  Josef Lakonishok,et al.  Contrarian Investment, Extrapolation, and Risk , 1993 .

[42]  Jr. James L. Farrell.  Analyzing Covariation of Returns to Determine Homogeneous Stock Groupings , 1974 .

[43]  Barr Rosenberg and Vinay Marathe.,et al.  Tests of Capital Asset Pricing Hypotheses , 1975 .

[44]  F. Black,et al.  The Capital Asset Pricing Model: Some Empirical Tests , 2006 .

[45]  M. Deaton,et al.  Response Surfaces: Designs and Analyses , 1989 .

[46]  Kalman J. Cohen,et al.  An Empirical Evaluation of Alternative Portfolio-Selection Models , 1967 .

[47]  Jot Yau,et al.  The Inefficient Stock Market , 2001 .

[48]  Steven Bender,et al.  Why Your Next Japanese Portfolio Should be Market-Neutral — and How , 1995 .

[49]  Edwin J. Elton,et al.  Portfolio Theory, 25 Years After. , 1981 .

[50]  Josef Lakonishok,et al.  Fundamentals and Stock Returns in Japan , 1991 .

[51]  Bernell K. Stone,et al.  Systematic Interest-Rate Risk in a Two-Index Model of Returns , 1974, Journal of Financial and Quantitative Analysis.

[52]  J. Lintner.  THE VALUATION OF RISK ASSETS AND THE SELECTION OF RISKY INVESTMENTS IN STOCK PORTFOLIOS AND CAPITAL BUDGETS , 1965 .

[53]  J. Mossin.  EQUILIBRIUM IN A CAPITAL ASSET MARKET , 1966 .

[54]  Marc R. Reinganum.  The Arbitrage Pricing Theory: Some Empirical Results , 1981 .

[55]  ClarkeRoger,et al.  Portfolio Constraints and the Fundamental Law of Active Management , 2006 .

[56]  Bruce I. Jacobs,et al.  Enhanced Active Equity Strategies , 2006 .

[57]  H. Markowitz.  Investment for the Long Run: New Evidence for an Old Rule , 1976 .

[58]  Campbell R. Harvey,et al.  Fundamental Determinants of National Equity Market Returns: A Perspective on Conditional Asset Pricing , 1996 .

[59]  Sundaresh Ramnath,et al.  The Financial Analyst Forecasting Literature: A Taxonomy with Suggestions for Further Research , 2008 .

[60]  Portfolio theory, 25 years after : essays in honor of Harry Markowitz , 1979 .

[61]  Stephen A. Ross,et al.  The Arbitrage Pricing Theory Approach to Strategic Portfolio Planning , 1984 .

[62]  R. Haugen,et al.  Commonality in the Determinants of Expected Stock Returns , 1996 .

[63]  James L. Farrell,et al.  Portfolio management : theory and application , 1996 .

[64]  Harry M. Markowitz,et al.  Portfolio Optimization with Factors, Scenarios, and Realistic Short Positions , 2005, Oper. Res..

[65]  William N. Goetzmann,et al.  Active Portfolio Management , 1999 .

[66]  The evaluation of common stocks , 1959 .

[67]  Edwin J. Elton,et al.  Expectations and Share Prices , 1981 .

[68]  E. Fama,et al.  Size and Book-to-Market Factors in Earnings and Returns , 1995 .

[69]  W. Sharpe.  A Simplified Model for Portfolio Analysis , 1963 .

[70]  Phoebus J. Dhrymes,et al.  An empirical examination of the implications of arbitrage pricing theory , 1985 .

[71]  S. Ross.  The arbitrage theory of capital asset pricing , 1976 .

[72]  S. Ross,et al.  An Empirical Investigation of the Arbitrage Pricing Theory , 1980 .

[73]  Soonyong Park,et al.  120/20 Portfolios: Long-Only Managers' Way of Reaching for Higher Alpha , 2008 .

[74]  Dennis E. Logue,et al.  Foundations of Finance. , 1977 .

[75]  Jan Mossin.  Theory of financial markets , 1972 .

[76]  Narasimhan Jegadeesh,et al.  Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency , 1993 .

[77]  Elroy Dimson,et al.  Stock market anomalies , 1989 .

[78]  W. Sharpe.  OF FINANCIAL AND QUANTITATIVE ANALYSIS December 1971 A LINEAR PROGRAMMING APPROXIMATION FOR THE GENERAL PORTFOLIO ANALYSIS PROBLEM , 2009 .

[79]  Barr Rosenberg and Andrew Rudd..  The Yield/Beta/Residual Risk Tradeoff , 1978 .