A tale of two states: asymmetries in the UK small, value and momentum premiums

Abstract

This is the accepted version of the paper.This version of the publication may differ from the final published version. Permanent repository link AbstractThis paper performs comparative analysis of the asymmetries in size, value and momentum premium and their macroeconomic determinants over the UK economic cycles, using Markov switching approach. We associate Markov switching regime 1 with economic upturn and regime 2 with economic downturn. We find clear evidence of cyclical variations in the three premiums, most notable being that in the size premium, which changes from positive in expansions to negative in recessions. Macroeconomic indicators prompting such cyclicality the most are variables that proxy credit market conditions, namely the interest rates, term structure and credit spread. Overall, macro factors tend to have more significant impact on the three premiums during economic downturns. The results are robust to the choice of information variable used in modelling transition probabilities of the two-stage Markov switching model. We show that exploiting cyclicality in premiums proves particularly profitable for portfolios featuring small cap stocks in recessions at a feasible level of transaction costs. JEL classification: G11, E32

A Guide to Survival of Momentum in UK Style Portfolios

“…al (2012) and Avramov et al (2016) show that the strength of momentum profits varies over time. In addition, there is evidence that momentum in the UK exhibits a degree of cyclical behaviour (see Sarwar et. al, 2016).…”

“…We estimate the feasibility of our trading rule by calculating breakeven transaction costs, which represent maximum costs that investor can pay and still equalise the Sharpe ratio of the trading strategy to that of the buy and hold. Additionally, given that the strength of momentum profits varies over time (Stambaugh et al, 2012;and Avramov et al, 2016) and that UK momentum premium exhibits cyclical behaviour (Sarwar, Mateus and Todorovic, 2016), we evaluate if there are any differences in the probabilities of momentum trading across UK business cycles.…”