Timing the Value Style Index in a Markov Regime-Switching Model

Journal of Investment Managment (JOIM), First Quarter, 2012

Posted: 24 May 2012

See all articles by Hany Guirguis

Hany Guirguis

Manhattan College

Ted Theodore

affiliation not provided to SSRN

Micahel Suen

affiliation not provided to SSRN

Date Written: May 24, 2012

Abstract

We construct and test a popular indicator for timing value style investment: the earnings yield dispersion (EYD). Conventional wisdom holds that one should invest in value style when there is a wide dispersion in earnings yield (E/P ratios) across the equity market. This hypothesis is based on a simple argument: many value stocks are depressed during such periods, causing yields to increase and the EYD to widen. Investors believe that depressed prices are bound to revert upward, causing the dispersion to narrow. Using a Markov regime-switching model, we demonstrate that the effect of an EYD signal is conditional on the market regime. In a low-variance regime, an increase in EYD predicts positive returns for the value style index, as suggested by the conventional wisdom. In a high-variance regime, however, an increase in EYD predicts negative returns for the value style index. High-variance regimes tend to be associated with strong negative price momentum and overreacting, pessimistic investors. Thus, it is very difficult for depressed value stocks to bounce back in a high-variance regime. The effect of EYD during a high-variance regime is exactly opposite to the conventional wisdom prediction.

Keywords: Equity style timing, regime-switching, investor behavior, market timing, style investment

JEL Classification: G00

Suggested Citation

Guirguis, Hany and Theodore, Ted and Suen, Micahel, Timing the Value Style Index in a Markov Regime-Switching Model (May 24, 2012). Journal of Investment Managment (JOIM), First Quarter, 2012. Available at SSRN: https://ssrn.com/abstract=2066114

Hany Guirguis (Contact Author)

Manhattan College ( email )

Manhattan College Parkway
Riverdale, NY 10471
United States

Ted Theodore

affiliation not provided to SSRN ( email )

Micahel Suen

affiliation not provided to SSRN ( email )

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