Abstract
We propose a market-timing strategy that aims to exploit aggregate accruals' return forecasting power. Using several performance measures of the aggregate accruals-based market-timing strategy, such as excess portfolio return, Sharpe ratio, and Jensen's alpha, we find robust evidence that, relative to the passive investment strategy of buying and holding the stock market, the market-timing strategy delivers superior performance that is both statistically and economically significant. Specifically, on average, the market-timing strategy beats the S&P500 index by 6 to 22 percentage points (annualized) after controlling for transaction costs over the 1980–2004 period.
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Notes
We apply the balance sheet method to calculate individual firm's accruals as change in no-cash current assets minus the change in current liabilities, excluding change in short-term debt, change in tax payable and depreciation. The detail definition can be found on page 7.
We also calculate and use value-weighted aggregate discretionary accruals in our study and obtain very similar results. As computing value-weighted aggregate accruals is much easier for portfolio managers, we choose to focus on value-weighted aggregate accruals in the text.
We do not include in equation (3) other previously identified return predictors, such as cay, aggregate book-to-market ratio, aggregate equity issuances, and market sentiment measures. As shown in Kang et al (2006), the return forecasting power of value-weighted aggregate accruals is robust to the inclusion of these variables. Consistent with this result, we find that including these variables in equation (3) yields qualitatively similar results.
We also recursively compute the expected market return variance as the average market return variance from the beginning year of our sample, that is, 1965, up to the year of portfolio formation. The results remain similar.
References
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Acknowledgements
We gratefully acknowledge the financial support from the University Grant Committee of the Hong Kong Special Administrative Region, China (Project no. HKU 7472/06 H). All errors remain our own.
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Kang, Q., Liu, Q. & Qi, R. Market timing with aggregate accruals. J Asset Manag 10, 170–180 (2009). https://doi.org/10.1057/jam.2009.5
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DOI: https://doi.org/10.1057/jam.2009.5