Bridge over ocean
1 March 2007 Financial Analysts Journal Volume 63, Issue 2

Residual Income Approach to Equity Country Selection

  1. Stéphanie Desrosiers
  2. Natacha Lemaire
  3. Jean-Francois L'Her, CFA

The predictive power for country selection of expected returns estimated through the residual income model is examined through analysis of 19 developed-country indices for 1988–2005. Zero-investment strategies based on a ranking or optimization methodology—expected returns and conditional country risk estimates—posted significant positive performance over various holding periods. Risk-adjusted returns remained significant after control for four world risk factors—market, size, the book-to-market ratio, and momentum—constructed through a country stratification methodology based on stock constituents. The results were robust to various long-term growth estimates and to different country-universe subsamples and remained robust after transaction costs were taken into account.

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