Stock Returns and the Cross-Section of Characteristics: A Tree-Based Approach
17 Pages Posted: 18 May 2018
Date Written: April 27, 2018
We build regression trees to determine which firm characteristics are most likely to drive future returns. Out of 30 attributes, those related to momentum appear to have, by far, the most marked impact. This prominence is verified at the sector level as well. The second order effects are propelled by volatility and liquidity variables. Finally, we show that a realistic portfolio strategy based on the short-term RSI characteristic outperforms the naive 1/N portfolio by 2.4% per annum, once the transaction costs have been taken into account. One possible explanation for these higher returns is the immunity of the strategy to the momentum crash phenomenon.
Keywords: Regression trees, Cross-section of stock returns, Firm characteristics, Portfolio choice
JEL Classification: G12, G11, C44, C55
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