A theoretical and empirical analysis of value and growth stocks across European markets : an integrated approach

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NO FULL TEXT AVAILABLE. Access is restricted indefinitely. ----- The well-documented market underperformance of the majority of value and growth stocks over a 12-month holding period reflects the fact that traditional valuation metrics might tell us whether a stock is potentially cheap or expensive, but little about when, or even if, it will experience a market correction. Two indicators, providing useful insights in this direction, have come to the fore in recent years: market sentiment and accounting fundamentals. We examine their single and combined impact in a European sample, and find that, though the sentiment metric completely dominates the accounting metric, they both are effective in introducing a timing dimension into the stock selection process, which enhances the performance of value and growth portfolios. We argue that our findings are consistent with the stock pricing cycle proposed by Lee and Swaminathan [2000] and with the market under- and over-reaction inherent in models proposed by Barberis et al [1998] and Hong and Stein [ 1999]. In addition, the intertemporal macroeconomic dependence of the performance of value and growth stocks motivates the implementation of a strategy that rotates between being value- and growth-oriented, before timing the life cycle of each stock by its sentiment and financial health. Finally, we develop a more realistic approach to portfolio construction that is subject to different trading cost schemes and risk controls. The aim is to test the performances of the previously enhanced value and growth strategies, with the objective of quantifying the realism and persistency of the resulting portable alphas, whose extent and significance question the efficiency of the European equity markets.
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