Economic momentum and equity returns
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School of Business | Master's thesis
AbstractIn this thesis, I take inspiration from Dahlquist and Hasseltoft (2020), who find that investing in the currency market according to past trends in macroeconomic indicators generates significant excess returns not explained by conventional risk factors and currency trading strategies. I expand their approach to the universe of equity indices by creating a trading strategy that invests in international equity indices according to past trends in economic momentum, attempting to take advantage of equity return predictability, which has been vastly studied and documented in academia. I show that equity return predictability can be harnessed into a profitable investment strategy by investing in indices of countries with negative macroeconomic trends, while short-selling indices of countries with positive macroeconomic trends. Although some of the performance has eroded over time, using an investment signal consisting of a combination of industrial production, retail sales, and the inverse of unemployment, proves robust also in subsamples split by timeframe or geography. No conventional risk factors are able to explain these returns, however it should be noted that I have not accounted for transaction costs when running the strategies in historical data.
Thesis advisorSuominen, Matti
economic momentum, equities, index, investment strategy