Directional Information in Equity Returns

91 Pages Posted: 13 Oct 2023

See all articles by Luca Del Viva

Luca Del Viva

ESADE Business School

Carlo Sala

ESADE Business School

André B.M. Souza

ESADE Business School

Date Written: September 19, 2023

Abstract

We document the existence of sign predictability in equity returns. An investment strategy that buys stocks deemed most likely to have positive returns and sells stocks with the lowest probability of positive returns generates about 1% monthly alpha and is not explained by established asset pricing models. The proposed strategy has higher Sharpe ratios and exhibits fewer crashes than the renowned momentum strategy. We show that profits from exploiting directional information are driven by shifts in retail investors’ expectations after periods of excessive pessimism or optimism, rather than compensation for risk. We provide a simple model to motivate our findings.

Keywords: Sign predictability, biased expectations, mispricing, momentum, crashes

JEL Classification: G11, G12

Suggested Citation

Del Viva, Luca and Sala, Carlo and Souza, André B.M., Directional Information in Equity Returns (September 19, 2023). Available at SSRN: https://ssrn.com/abstract=4575793 or http://dx.doi.org/10.2139/ssrn.4575793

Luca Del Viva (Contact Author)

ESADE Business School ( email )

Av. de Pedralbes, 60-62
Barcelona, 08034
Spain

Carlo Sala

ESADE Business School ( email )

Avenida de Torreblanca 59
Barcelona, Barcelona 08172
Spain

HOME PAGE: http://www.people.usi.ch/salaca

André B.M. Souza

ESADE Business School ( email )

Av. de Pedralbes, 60-62
Barcelona, 08034
Spain

HOME PAGE: http://www.andrebmsouza.com

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