Daily Academic Alpha: Out-of-Sample Testing
The objective of this thesis is to develop and back-test an investment strategy created by professors Wesley R. Gray and Tobias E. Carlisle in their book Quantitative Value, published in 2013. Gray and Carlisle construct a quantitative strategy based on Warren Buffet’s investment philosophy and when back-tested, show that the strategy has been able to outperform the S&P500 TR Index for the last 40 years. The author tries to replicate the results shown by Gray and Carlisle for the US stock market which, despite the short period analyzed, gives promising results as the strategy generates a positive Jensen’s alpha that is statistically significant. When implemented for the Icelandic stock market the results are very impressive as the model’s return is significantly higher than the market’s. The model also manages to outperform Icelandic equity funds over a recent 18 month period, generating the highest Jensen’s alpha that is also statistically significant. The author set out to see if the model could be improved by introducing a new measure; return on invested capital (ROIC). The model’s results with ROIC included were impressive but did not improve the performance of the original model. However, due to the small sample size, the author believes that the result give cause to further research. The results support Gray and Carlisle’s findings that they have managed to find a model that systematically picks value stocks that generate excess returns.
Recently, Fama and French (2014) document a five-factor model that includes the market and factors related to size, book-to-market, profitability and investment outperforms the three-factor model of Fama and French (1993). Using an extensive sample over the period 1982 to 2013, we investigate the performance of the five-factor model in pricing Australian equities. We find that the five-factor is able to explain more asset-pricing anomalies than the three-factor model, which supports the superiority of the five-factor model. In contrast to that documented in Fama and French (2014), the book-to-market factor is found to remain its explanatory power in the presence of the investment and profitability factors. Our study provides an update to the existing Australian asset pricing literature.
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Definitions of common statistics used in our analysis are available here (towards the bottom)