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A tale of two states: asymmetries in the UK small, value and momentum premiums

Sarwar, G., Mateus, C. and Todorovic, N. (2017). A tale of two states: asymmetries in the UK small, value and momentum premiums. Applied Economics, 49(5), pp. 456-476. doi: 10.1080/00036846.2016.1200184

Abstract

This article performs comparative analysis of the asymmetries in size, value and momentum premium and their macroeconomic determinants over the UK economic cycles, using Markov switching approach. We associate Markov switching regime 1 with economic upturn and regime 2 with economic downturn. We find clear evidence of cyclical variations in the three premiums, most notable being that in the size premium, which changes from positive in expansions to negative in recessions. Macroeconomic indicators prompting such cyclicality the most are variables that proxy credit market conditions, namely the interest rates, term structure and credit spread. Overall, macro factors tend to have more significant impact on the three premiums during economic downturns. The results are robust to the choice of information variable used in modelling transition probabilities of the two-stage Markov switching model. We show that exploiting cyclicality in premiums proves particularly profitable for portfolios featuring small cap stocks in recessions at a feasible level of transaction costs.

Publication Type: Article
Additional Information: This is an Accepted Manuscript of an article published by Taylor & Francis in Applied Economics on 2 Jul 2016, available online: http://www.tandfonline.com/10.1080/00036846.2016.1200184
Publisher Keywords: Size, value and momentum premiums, two-state Markov switching model, macroeconomic determinants, cyclicality, G11, E32
Subjects: H Social Sciences > HB Economic Theory
Departments: Cass Business School > Finance
URI: http://openaccess.city.ac.uk/id/eprint/15031
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