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Quantitative Portfolio Management

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Corporate Finance & Asset Valuation

MFIN7005C

Quantitative Portfolio Management

December 15. 2016

Part 1: Introduction

 

Benjamin Graham and David L. Dodd’s trading strategies of “Value Investing” introduced in the book “Security Analysis” have been widely used by investors for decades. One of the major principles of investment discussed in the book is to analyze earnings and asset values of a company to before deciding particular trading rules. To investigate Graham and Dodd’s trading strategy, Chan, Hamao and Lakonishok investigated the average monthly returns for portfolios in Tokyo stock exchange from 1971 to 1988; the study indicated a positive relationship of realized return with both non-negative Earning-to-Price ratio and Book-to-Market price ratio.

 

The main objective of this project is to use “Backtesting” methodology to investigate the Earning-to-Price effect and Book-to-Market effect in the Hong Kong stock market, and to examine whether the trading strategies of “Value Investing” proposed in the book work in the Hong Kong stock market.

 

Part 2: Methodology

 

We would use “Backtesting” as a major methodology to investigate the Earning-to-Price effect and Book-to-Market effect in the Hong Kong stock market from 1981 to 1995.

 

For the analysis of Earning-to-Price effect, we form portfolios by E/P ratios at least 6 months after the fiscal year end for the accounting figure. Each year, we construct 0th portfolio by stocks with Non-positive Earning-to-Price ratio, and construct 1st to 5th portfolios by stocks with smallest to largest Earning-to Price ratio. Assuming that each portfolio has equal weightings for its constituent stocks, we calculate and compare the realized return of the 1st portfolio and 5th portfolio. The same process would be repeated throughout 1981 to 1995.The same methodology would also be applied to the analysis of Book-to-Market value effect.

 

The observations and analysis of the relationships between portfolios realized returns and E/P, B/M ratios would be discussed in the project. The limitations of methodology and suggestions on related trading strategies would also be presented in the last part of the project.

Part 3: Observations & Analysis of Relationship Between Realized Return and E/P, B/M Ratio

3.1 Earnings-to-Price Ratio and Realized Return.

Year

Lowest E/P

Highest E/P

Difference

Lowest B/M

Highest B/M

Difference

(1)

(2)

(3)=(2)-(1)

(4)

(5)

(6)=(5)-(4)

1981

-10.36%

34.51%

44.86%

-33.79%

27.30%

61.09%

1982

-27.01%

14.71%

41.72%

-6.55%

-6.50%

0.05%

1983

33.49%

33.57%

0.08%

51.60%

30.43%

-21.17%

1984

51.49%

98.90%

47.41%

64.27%

84.40%

20.13%

1985

10.69%

36.11%

25.43%

20.74%

78.36%

57.62%

1986

131.29%

177.10%

45.81%

71.57%

166.84%

95.28%

1987

-3.11%

29.99%

33.10%

19.30%

32.81%

13.51%

1988

-5.81%

-1.47%

4.33%

-19.02%

-7.96%

11.06%

1989

84.23%

89.70%

5.47%

70.83%

120.89%

50.06%

1990

-15.66%

1.59%

17.25%

-8.52%

3.91%

12.44%

1991

73.03%

47.00%

-26.02%

29.14%

67.80%

38.66%

1992

72.65%

65.09%

-7.47%

16.18%

81.91%

65.73%

1993

-5.04%

2.25%

7.28%

2.75%

9.57%

6.81%

1994

-14.16%

-17.10%

-2.94%

-11.93%

-14.08%

-2.15%

1995

5.03%

8.82%

3.79%

16.88%

8.02%

-8.86%

Average

25.34%

41.38%

16.03%

18.90%

45.58%

26.68%

Table 3-1:Average Realized Return of Highest/Lowest E/P and B/M from 1981 to 1995

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