Residual Income Approach to Equity Country Selection

Abstract

The predictive power for country selection of expected returns estimated through the residual income model is examined through analysis of 19 developed-country indices for 1988-2005. Zero-investment strategies based on a ranking or optimization methodology — expected returns and conditional country risk estimates — posted significant positive performance over various holding periods. Risk-adjusted returns remained significant after control for four world risk factors — market, size, the book-to-market ratio, and momentum — constructed through a country stratification methodology based on stock constituents. The results were robust to various long-term growth estimates and to different country-universe subsamples and remained robust after transaction costs were taken into account.

Keywords: Portfolio Management, Asset Allocation, Portfolio Construction, Rebalancing, and Implementation, Equity Investments, Technical Analysis