To investigate the relationship between value and momentum factors and how they may be correlated across countries, the authors examine developed international stock market data at the country level. They study how value and momentum factors respond to changing macroeconomic and liquidity conditions.
What’s Inside?
The authors examine 23 developed international stock markets to investigate the behavior of value and momentum factors. They note that for larger market-capitalization stocks, value and momentum premiums are both smaller and more negatively correlated.
In addition, momentum factors are found to be more highly correlated than value factors internationally. The authors also find that value factors are sensitive to economic cycles because prior to a recession, value returns are generally lower. Momentum returns show little similar sensitivity. Finally, when funding liquidity (defined as the bank cost of funds) is poor, value returns tend to be lower but momentum returns are not affected.
How Is This Research Useful to Practitioners?
Practitioners may find several useful aspects to this research. Because the authors find negative correlations between value factors in one country and momentum factors in another, international investors can obtain lower portfolio volatility by combining value and momentum factors across countries. Also, lower value returns may be predictive of lower future GDP growth. Finally, as might be expected, value returns are higher when transaction costs in the local stock market are higher.
How Did the Authors Conduct This Research?
Previous research has documented both value and momentum effects in the United States. Value stocks persist in having higher average returns relative to nonvalue stocks, and momentum stocks (stocks with recent high returns) have demonstrated continued outperformance. The authors seek to extend this analysis internationally by examining monthly return data at the firm level for the period of January 1990 to March 2012. The dataset includes 14,525 firms from 23 countries. GDP and consumption data for all countries are from the World Bank. The authors also incorporate five different funding liquidity variables, using data from the Center for Research in Security Prices (CRSP). Finally, they incorporate two variables to represent credit risk.
The authors calculate the four Fama and French asset pricing factors (market factor, small minus big, high minus low, and momentum). Then they construct six portfolios for each country on the basis of the three value factors and capitalization. The factor returns are then regressed against the macroeconomic variables.
They report five main results of interest. First, value and momentum effects are smaller for large-capitalization stocks in virtually all the countries studied, as they are in the United States. Second, within a country, value and momentum factors are negatively correlated and the correlations are more negative and significant for large stocks. Third, the authors report statistically significant correlations between value and momentum factors among different countries. Fourth, with respect to the capital asset pricing model, value factors generate significantly positive alphas in the Asia-Pacific region, Japan, and North America, whereas in Europe, momentum factors have significantly positive alphas. And fifth, value returns tend to be lower before a recession begins.
Abstractor’s Viewpoint
The authors provide a useful extension of the understanding of value and momentum effects for international stocks. Additionally, they provide some exploitable opportunities for the practitioner.