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Indexing, cointegration and equity market regimes
journal contribution
posted on 2023-06-08, 12:26 authored by Carol AlexanderCarol Alexander, Anca DimitriuThis paper examines, from a market efficiency perspective, the performance of a simple dynamic equity indexing strategy based on cointegration. A consistent ‘abnormal’ return in excess of the benchmark is demonstrated over different time horizons and in different real world and simulated stock markets. A measure of stock price dispersion is shown to be a leading indicator for the abnormal return and their relationship is modelled as a Markov switching process of two market regimes. We find that the entire abnormal return is associated with the high volatility regime as the indexing model implicitly adopts a strategic position that pays off during market crashes, whilst effectively tracking the benchmark in normal market circumstances. Therefore we find no evidence of market inefficiency. Nevertheless our results have implications for equity fund managers: we show how, without any stock selection, solely through a smart optimization that has an implicit element of market timing, the benchmark performance can be significantly enhanced.
History
Publication status
- Published
Journal
International Journal of Finance & EconomicsISSN
1076-9307Publisher
John Wiley & SonsExternal DOI
Issue
3Volume
10Page range
213-231Department affiliated with
- Business and Management Publications
Full text available
- No
Peer reviewed?
- Yes