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Case Closed

Robert A. Haugen

Haugen Custom Financial Systems

Nardin L. Baker

Guggenheim Investments

November 20, 2008


This article provides conclusive evidence that the U.S. stock market is highly inefficient. Our results, spanning a 45 year period, indicate dramatic, consistent, and negative payoffs to measures of risk, positive payoffs to measures of current profitability, positive payoffs to measures of cheapness, positive payoffs to momentum in stock return, and negative payoffs to recent stock performance. Our comprehensive expected return factor model successfully predicts future return, out of sample, in each of the forty-five years covered by our study save one. Stunningly, the ten percent of stocks with highest expected return, in aggregate, are low risk and highly profitable, with positive trends in profitability. They are cheap relative to current earnings, cash flow, sales, and dividends. They have relatively large market capitalization and positive price momentum over the previous year. The ten percent with lowest expected return (decile 1) have exactly the opposite profile, and we find a smooth transition in the profiles as we go from 1 through 10. We split the whole 45-year time period into five sub-periods, and find that the relative profiles hold over all periods. Undeniably, the highest expected return stocks are, collectively, highly attractive; the lowest expected return stocks are very scary - results fatal to the efficient market hypothesis. While this evidence is consistent with risk loving in the cross-section, we also present strong evidence consistent with risk aversion in the market aggregate's longitudinal behavior. These behaviors cannot simultaneously exist in an efficient market.

Number of Pages in PDF File: 27

Keywords: efficient market, factor model, markowitz, optimization, inefficient market, risk

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Date posted: November 26, 2008 ; Last revised: April 22, 2009

Suggested Citation

Haugen , Robert A. and Baker, Nardin L., Case Closed (November 20, 2008). THE HANDBOOK OF PORTFOLIO CONSTRUCTION: CONTEMPORARY APPLICATIONS OF MARKOWITZ TECHNIQUES, John B. Guerard Jr., ed., Forthcoming. Available at SSRN: https://ssrn.com/abstract=1306523

Contact Information

Robert A. Haugen (Contact Author)
Haugen Custom Financial Systems ( email )
128 W. 14th Street
Suite 201
Durango, CO 81301
United States
(970) 259-9512 (Phone)
HOME PAGE: http://www.haugensystems.com
Nardin L. Baker
Guggenheim Investments ( email )
500 Boylston
13th Floor
Boston, MA 02116
United States
617.859.4651 (Phone)
HOME PAGE: http://guggenheimpartners.com/
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