Does long-term disequilibrium in stock price predict future returns?

Does long-term disequilibrium in stock price predict future returns? We propose a trading strategy based on error correction term (ECT), the residuals from the cointegration relation between the levels of security and the market portfolio. We find that buying stocks in the top 10 % ECT and selling stocks in the bottom 10 % ECT generates 1.09 % a month for 6-month holding period over 1965–2005. The monthly return increases to 1.57 % when the above trading strategy is applied to stocks with insignificant cointegration with the market portfolio. This profit is robust to three and four factor models. Moreover, this profit is neither driven by small and illiquid stocks nor is the result of any inherent positive serial correlation. Review of Quantitative Finance and Accounting Springer Journals

Does long-term disequilibrium in stock price predict future returns?

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Springer US
Copyright © 2012 by Springer Science+Business Media New York
Economics / Management Science; Finance/Investment/Banking; Accounting/Auditing; Econometrics; Operations Research/Decision Theory
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  • Indexing, cointegration and equity market regimes
    Alexander, C; Dimitriu, A

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