Indexing, cointegration and equity market regimes

Alexander, Carol and Dimitriu, Anca (2005) Indexing, cointegration and equity market regimes. International Journal of Finance & Economics, 10 (3). pp. 213-231. ISSN 1076-9307

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This paper examines, from a market efficiency perspective, the performance of a simple dynamic equity indexing strategy based on cointegration. A consistent ‘abnormal’ return in excess of the benchmark is demonstrated over different time horizons and in different real world and simulated stock markets. A measure of stock price dispersion is shown to be a leading indicator for the abnormal return and their relationship is modelled as a Markov switching process of two market regimes. We find that the entire abnormal return is associated with the high volatility regime as the indexing model implicitly adopts a strategic position that pays off during market crashes, whilst effectively tracking the benchmark in normal market circumstances. Therefore we find no evidence of market inefficiency. Nevertheless our results have implications for equity fund managers: we show how, without any stock selection, solely through a smart optimization that has an implicit element of market timing, the benchmark performance can be significantly enhanced.

Item Type: Article
Keywords: Cointegration;dispersion;efficient market hypothesis;equity markets;index tracking;Markov switching;market timing
Schools and Departments: School of Business, Management and Economics > Business and Management
Subjects: H Social Sciences > HG Finance
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Depositing User: Catrina Hey
Date Deposited: 18 Sep 2012 11:27
Last Modified: 18 Sep 2012 11:27
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