Abnormal Returns in Equity Markets: Evidence from a Dynamic Indexing Strategy
30 Pages Posted: 2 Apr 2003
Date Written: January 20, 2003
Abstract
This paper investigates the abnormal return generated through a dynamic equity indexing strategy and the extent to which this can be considered evidence against the efficient markets hypothesis. We introduce a new measure of stock price dispersion and show that it is a leading indicator for the abnormal return, where their relationship is based on a switching process of two market regimes. The entire abnormal return is associated with only one of the regimes and this is the prevalent regime during the last few years. The predictive power of the model is demonstrated over different time horizons and in different, real world and simulated stock markets. The strategy remains profitable even after introducing transaction costs, thus proving evidence of temporary market inefficiencies.
Keywords: index tracking, cointegration, Markov switching, dispersion, equity markets, long-run equilibrium prices
JEL Classification: C23, C51, G11, G23
Suggested Citation: Suggested Citation
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