The Predictability of Stock Returns: A Cross-Sectional Simulation
Posted: 10 Oct 1998
This paper investigates whether predictable patterns that previous empirical work in finance have isolated appear to be persistent and exploitable by portfolio managers. On a sample that is free from survivorship bias we construct a test wherein we simulate the purchases and sales an investor would undertake to exploit the predictable patterns, charging the appropriate transaction costs for buying and selling and using only publicly available information at the time of decisionmaking. We restrict investment to large companies only to assure that the full cost of transactions is properly accounted for. We confirmed on our sample that contrarian strategies yield sizable excess returns after adjusting for risk, as measured by beta. Using analysts' estimates of long term growth we construct a test of the Lakonishok, Shleifer and Vishny (1994) hypothesis. We reach the conclusion that, contrary to Lakonishok et al. (1994), the superior performance of contrarian strategies can not be explained by the superior performance of stocks with low estimated growth rates.
JEL Classification: G12, G14
Suggested Citation: Suggested Citation