The Sophisticated and the Simple: The Profitability of Contrarian Strategies

54 Pages Posted: 26 Oct 2008

See all articles by Gishan Dissanaike

Gishan Dissanaike

University of Cambridge - Judge Business School

Kim-Hwa Lim

University of Cambridge - Judge Business School

Multiple version iconThere are 2 versions of this paper

Date Written: October 21, 2008

Abstract

A variety of variables have been used to form contrarian portfolios, ranging from relatively simple measures, like book-to-market, cash flow-to-price, earnings-to-price and past returns, to more sophisticated measures based on the Ohlson model and residual income model (RIM). This paper investigates whether: (i) contrarian strategies based on RIM perform better or worse than those based on the Ohlson model; (ii) contrarian strategies based on more sophisticated valuation models (e.g. Ohlson and RIM) perform much better than the relatively simpler ranking variables that have been used so extensively in the finance literature. Given that the RIM and Ohlson models require greater information inputs and technical know-how, and make different implicit assumptions on future abnormal earnings, it is important to ascertain if they offer significantly greater contrarian profits to outweigh the increased costs that they entail. Indeed, our surprising finding is that simple cash flow-to-price measures appear to do almost as well as the more sophisticated alternatives. One would have expected the sophisticated models to significantly outperform the simple cash flow-to-price model for the reasons given by Penman (2007).

Keywords: Capital markets, Valuation, Market efficiency

JEL Classification: M41, G12, G14

Suggested Citation

Dissanaike, Gishan and Lim, Kim-Hwa, The Sophisticated and the Simple: The Profitability of Contrarian Strategies (October 21, 2008). European Financial Management Journal, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1287808

Gishan Dissanaike (Contact Author)

University of Cambridge - Judge Business School ( email )

Trumpington Street
Cambridge, CB2 1AG
United Kingdom
+441 223 339626 (Phone)
+441 223 339701 (Fax)

Kim-Hwa Lim

University of Cambridge - Judge Business School ( email )

Trumpington Street
Cambridge, CB2 1AG
United Kingdom

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