Investing in Stock Market Anomalies
Turan G. Bali
Georgetown University - Robert Emmett McDonough School of Business
Stephen J. Brown
New York University - Stern School of Business
K. Ozgur Demirtas
CUNY Baruch College - Zicklin School of Business
January 31, 2012
For the last three decades, one of the most extensively investigated topics in financial economics is the crosssectional variation in stock returns. There are certain patterns in equity portfolios that are considered as anomalies because they cannot be explained by well-known asset pricing models. Each year billions of dollars are invested in portfolios based on anomalies which identify undervalued assets with high expected returns and overvalued assets with low expected returns. However, classical selection rules in financial economics fail to explain this investment behavior. This paper utilizes the almost dominance rules to examine the practice of investing in stock market anomalies. The results indicate that popular investment choices such as value and small stocks do not dominate growth and big stocks, whereas, the short-term reversal and momentum strategies create efficient investment alternatives. The relative strength of undervalued assets becomes more prevalent when the time-varying conditional distributions and broader portfolio comparisons are examined. Hence, the paper solves the wide inconsistency between the common practice in mutual and hedge funds’ asset allocation decision and modern portfolio theory by providing an explanation of investing in an expected utility paradigm.
Number of Pages in PDF File: 50
Keywords: Mutual funds, equity portfolios, expected utility paradigm, stock market anomalies
JEL Classification: G10, G11, G12working papers series
Date posted: February 1, 2012 ; Last revised: February 27, 2012
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