quantitative stock selection2 quantitative stock selection 1. introduction issue two decisions are...

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Quantitative Stock SelectionQuantitative Stock Selection

Campbell R. Harvey

Global Asset Allocation and Stock Selection

Quantitative Stock Selection1. Introduction

Research coauthored with• Dana Achour• Greg Hopkins• Clive Lang

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IssueTwo decisions are important:• Asset Allocation (country picks)• Asset Selection (equity picks)


Issue• Considerable research on the asset

allocation side• Research has paid off in that many models

avoided “overvalued” Asian markets inmid-1990s

• Many models began overweighing after theonset of the Asia Crisis

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Issue• Little research on the stock selection side.

Why?– Sparse data on individual stocks– Information asymmetries among local and

global investors– Extremely high transactions costs


With recent plummet in emerging markets,stock selection is important.

If market is deemed “cheap,” (as manyasset allocation models would now suggest),which stocks do we select?

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Quantitative Stock Selection2. Stock Selection Metrics

Ingredients for success:• Identify stable relationships• Attempt to model unstable relationships• Use predictor variables that reflect the

future, not necessarily the past• Do not overfit• Validate in up-markets as well as down• Tailor to country characteristics in emerging

markets


Methodologies:• Cross-sectional regression• Sorting• Hybrids

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Cross-sectional regression:For country j, estimate:

wherei denotes firm i;A is a firm specific attribute (could be multiple)γ are common regression coefficients

tititi AR ,1,10, εγγ ++= −


Cross-sectional regression:• Used in developed market stock selection• Problem with unstable coefficients• Bigger problem given noisy emerging market

returns

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Sorting:• Used in developed market stock selection• Potentially similar in stability problems• Can be cast in regression framework

– (a regression on ranks, or a multinomial probitregression)

• Rank regression may have advantages giventhe high variance (high noise) in emergingequity returns


Sorting:• Simple methodology that provides a good

starting point to investigate stock selection

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Hybrid:• Create portfolios based on stocks sorted by

attributes• Use regression or optimization to weight

portfolios• Produces a flexible, highly nonlinear way to

select stocks

Quantitative Stock Selection3. Our methodology

Focus on three emerging markets:• Malaysia (representative of Asia)• Mexico (indicative of Latin America)• South Africa (unique situation)

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Specify exhaustive list of firm specific factors• Includes many traditional factors• Extra emphasis on expectations factors

Specific a number of diagnostic variables• Includes factors that reflect the type of firm we

are selecting


Identify the best stocks and the worst stocks• Do not impose the constraints of a tracking

error methodology [Tracking error can be dealt with at a later

stage of the analysis]

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Steps:

1. Specify list of factors2. Univariate screens (in sample)3. Bivariate diagnostic screens4. Battery of additional diagnostics emphasizing performance through time5. Bivariate selection screens


Steps:

6. Optimize to form “scoring screen” (in sample)7. Run scoring screen on out-of-sample period8. Diagnostics on scoring screen9. Form “buy list” and “sell lists”10. Purge “buy list” of stocks that are identified

by predetermined set of “knock out criteria”

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Steps:

11. Investigate turnover of portfolio– various holding periods analyzed

Quantitative Stock Selection4. Past research

Very few papers:• Rouwenhorst (JF) looks at IFC data• Claessens, Dasgupta and Glen (EMQ) look at

IFC data• Fama and French (JF) look at IFC data• Achour, Harvey, Hopkins, Lang (1998, 1999,

2000)

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Quantitative Stock Selection4. Past research

What we offer:• No one has merged IFC, MSCI, Worldscope,

and IBES data• First paper to look at comprehensive list of

firm attributes• First paper to look at expectational attributes

Quantitative Stock Selection4. Factors

Fundamental factors• Dividend yield• Earnings yield• Book to price ratio• Cash earnings to price yield• Change in return on equity• Revenue growth• Rate of re-investment• Return on equity

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Expectational• Change in consensus FY1 estimate - last 3

or 6 months• Consensus FY2 to FY1 estimate change• Consensus forecast earnings estimate

revision ratio• 12 months prospective earnings growth rate• 3 year prospective earnings growth rate• 12 month prospective earnings yield


Momentum• One month/ 1 year price momentum• One year historical earnings

growth/momentum• Three year historical earnings growth rate

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Diagnostic• Market capitalization• Debt to common equity ratio

Quantitative Stock Selection5. Diagnostics

• Average return• Average excess return• Standard deviation• T-stat (hypothesis that excess return=0)• Beta (against benchmark index)• Alpha• R2

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• Average capitalization• % periods > market index (hit rate)• % periods > market index in up markets• % periods > market index in down markets• Max number of consecutive benchmark

outperformances


• Max observed excess return• Min observed excess return• Max number of consecutive negative returns• Max number of consecutive positive returns• Year by year returns

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• Factor average for constructed portfolio• Factor median• Factor standard deviation

050

100150200250300350400

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Malaysia IFC US$ Malaysia FX

Quantitative Stock Selection6. Summary Statistics: Malaysia Benchmark

87% drop

Data through January 2001

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0100200300400500600700800900

1000

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Mexico IFC Mexico FX

Quantitative Stock Selection6. Summary Statistics: Mexico Benchmark

68% drop


0

50

100

150

200

250

300

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

South Africa IFC US$ South Africa FX

Quantitative Stock Selection6. Summary Statistics: South Africa Benchmark

55% drop


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-30

-25

-20

-15

-10

-5

0

5

10

15

CapD ROI

D/E Div

1 Yr E

arn M

om

3 Yr E

arn M

om E/P

D FYI 3m

o

D FYI 6m

o

FY1 t

o FY2

Rev Ratio B/P

CE/P

1 mo M

om

1 yr M

om

Prop E

/P

Prop 3

yr D Ea

rn

12 m

o Prop

E/P

24 m

o Prop

E/P

D Rev

Reinves

tROE

Index

return

Top Bottom

Quantitative Stock Selection6. Malaysia: Factor returns

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0

5

10

15

20

25

30

35

CapD ROI

D/E Div

1 Yr E

arn M

om

3 Yr E

arn M

om E/P

D FYI 3m

o

D FYI 6m

o

FY1 t

o FY2

Rev Ratio B/P

CE/P

1 mo M

om

1 yr M

om

Prop E

/P

Prop 3

yr D Ea

rn

12 m

o Prop

E/P

24 m

o Prop

E/P

D Rev

Reinves

tROE

Index

return

Top Bottom

Quantitative Stock Selection6. Mexico: Factor returns

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0

5

10

15

20

25

30

CapD ROI

D/E Div

1 Yr E

arn M

om

3 Yr E

arn M

om E/P

D FYI 3m

o

D FYI 6m

o

FY1 t

o FY2

Rev Ratio B/P

CE/P

1 mo M

om

1 yr M

om

Prop E

/P

Prop 3

yr D Ea

rn

12 m

o Prop

E/P

24 m

o Prop

E/P

D Rev

Reinves

tROE

Index

return

Top Bottom

Quantitative Stock Selection6. South Africa: Factor returns

0

10

20

30

40

50

60

70

CapD ROI

D/E Div

1 Yr E

arn M

om

3 Yr E

arn M

om E/P

D FYI 3m

o

D FYI 6m

o

FY1 t

o FY2

Rev Ratio B/P

CE/P

1 mo M

om

1 yr M

om

Prop E

/P

Prop 3

yr D Ea

rn

12 m

o Prop

E/P

24 m

o Prop

E/P

D Rev

Reinves

tROE

Top Bottom

Quantitative Stock Selection6. Malaysia: % Periods Benchmark Outperformance

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0

10

20

30

40

50

60

70

CapD ROI

D/E Div

1 Yr E

arn M

om

3 Yr E

arn M

om E/P

D FYI 3m

o

D FYI 6m

o

FY1 t

o FY2

Rev Ratio B/P

CE/P

1 mo M

om

1 yr M

om

Prop E

/P

Prop 3

yr D Ea

rn

12 m

o Prop

E/P

24 m

o Prop

E/P

D Rev

Reinves

tROE

Top Bottom

Quantitative Stock Selection6. Mexico: % Periods Benchmark Outperformance

0

10

20

30

40

50

60

70

CapD ROI

D/E Div

1 Yr E

arn M

om

3 Yr E

arn M

om E/P

D FYI 3m

o

D FYI 6m

o

FY1 t

o FY2

Rev Ratio B/P

CE/P

1 mo M

om

1 yr M

om

Prop E

/P

Prop 3

yr D Ea

rn

12 m

o Prop

E/P

24 m

o Prop

E/P

D Rev

Reinves

tROE

Top Bottom

Quantitative Stock Selection6. South Africa: % Periods Benchmark Outperformance

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0

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100

150

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250

1989

1990

1991

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1998

Top Benchmark Bottom

Quantitative Stock Selection6. Malaysia: Dividend Yield Screen: Index=100 each year

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Quantitative Stock Selection6. Mexico: Historical Earnings Momentum Screen: Index=100 each year

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0

20

40

6080

100

120140

160

180

200

1993

1994

1995

1996

1997

1998


Quantitative Stock Selection6. South Africa: Change in Consensus FY1-3 mo. Screen: Index=100 each year

-50-40-30-20-10

01020304050

1989

1990

1991

1992

1993

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1997

1998

Mal

aysia

Mex

ico

Sout

h A

fric

aQuantitative Stock Selection6. Book to Price: Low-High Spread

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-50-40-30-20-10

01020304050

1989

1990

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1998

Mal

aysia

Mex

ico

Sout

h A

fric

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Quantitative Stock Selection6. IBES Revision Ratio: Low-High Spread

-50-40-30-20-10

01020304050

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

Mal

aysia

Mex

ico

Sout

h A

fric

aQuantitative Stock Selection6. IBES 12-month Prospective Earnings Yield: L-H Spread

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-50-40-30-20-10

01020304050

1989

1990

1991

1992

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Mal

aysia

Mex

ico

Sout

h A

fric

a

Quantitative Stock Selection6. One-year Momentum: Low-High Spread

-50-40-30-20-10

01020304050

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

Mal

aysia

Mex

ico

Sout

h A

fric

aQuantitative Stock Selection6. Size Effect: Low-High Spread

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0

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Monthly

Quarterl

y

Semian

nual

Semian

nual w

/KOMark

et

Top Bottom

Quantitative Stock Selection6. Malaysia: Scoring Screen Various Holding Periods

0

5

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Monthly

Quarterl

y

Semian

nual

Market

Top Bottom

Quantitative Stock Selection6. Mexico: Scoring Screen Various Holding Periods

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-10

-5

0

5

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Monthly

Quarterl

y

Semian

nual

Market

Top Bottom

Quantitative Stock Selection6. South Africa: Scoring Screen Various Holding Periods

0102030405060708090

100

Monthly

Quarterl

y

Semian

nual

Semian

nual w

/KO

Top Bottom

Quantitative Stock Selection6. Malaysia: Scoring Screen % Periods Benchmark Outperformance

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0102030405060708090

100

Monthly

Quarterl

y

Semian

nual

Top Bottom

Quantitative Stock Selection6. Mexico: Scoring Screen % Periods Benchmark Outperformance

0102030405060708090

100

Monthly

Quarterl

y

Semian

nual

Top Bottom

Quantitative Stock Selection6. South Africa: Scoring Screen % Periods Benchmark Outperformance

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0

50

100

150

200

250

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

Top Bottom

Quantitative Stock Selection6. Malaysia: Scoring Screen: Index=100 each year

0

50

100

150

200

250

300

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

Top Bottom

Quantitative Stock Selection6. Mexico: Scoring Screen: Index=100 each year

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0

2040

60

80100

120140

160

180200

1993

1994

1995

1996

1997

1998

Top Bottom

Quantitative Stock Selection6. South Africa: Scoring Screen: Index=100 each year

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12/31/88 12/31/89 12/31/90 12/31/91 12/31/92 12/31/93 12/31/94 12/31/95 12/31/96 12/31/97

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IFCG MALAYSIA

IN SAMPLE OUT OF SAMPLE

TOP FR

IFCG MALAYSIA

BOTTOM


IBES DATA ADDED

Quantitative Stock Selection6. Malaysia: Scoring Screen

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Quantitative Stock Selection6. Mexico: Scoring Screen

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TOP

IFCG MEXICO

BOTTOM


Quantitative Stock Selection6. South Africa: Scoring Screen

0.00

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12/31/92 12/31/93 12/31/94 12/31/95 12/31/96 12/31/97

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TOP

BOTTOM

IFCG SOUTH AFRICA


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Quantitative Stock Selection7. Research Directions

1) Comparison of regression method andmultivariate screening process– Panel multinomial probit models– How do we reduce the noise in emerging market

equity returns?


2) What are the characteristics of countries thatmake some factors work and other not work?– Stage of market integration process– Industrial mix– Openness of economy– Microstructure factors

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3) What causes the shifting importance of factorsthrough time, e.g. value versus growth?– Can the cross-section of many stock returns help

us identify when a factor is likely to work?


4) Can the country selection process be mergedwith the stock selection exercise?– Should “buy” portfolios be used in top-down

optimizations?– Does country-specific tracking error really matter

in global asset allocation?

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5) Should we expand our view of risk in both thestock selection and country selection exercises?– Mean, variance, skewness?– What are the driving forces of changing variance?– What are the determinants of skewness?

quantitative stock selection2 quantitative stock selection 1. introduction issue two decisions are...

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