In Good and in Bad Times? The Relation between Anomaly Returns and Market States

Abstract

We evaluate the relation between various anomalies/factors and market conditions using data comprising 57 countries from 1980 to 2019. The cross-section of anomalies performs significantly better during unfavorable market states. The value-weighted four-factor alpha is 49.2 bps in bad times while it amounts to 29.4 bps in good times. 92.9% of the performance gain can be attributed to the anomaly short side. Findings remain robust considering sentiment, recessions, and anomaly categories or regions. They underscore the overall importance of mispricing in explaining anomalies, while for certain individual anomalies, risk and data mining may still serve as potential explanations.

Keywords: Anomalies, international stock markets, market states, sentiment. market efficiency

JEL Classification: G12, G14, G15