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Market Timing with GEYR in Emerging Stock Market: The Evidence from Stock Exchange of Thailand

posted Jul 12, 2013, 6:28 AM by Nopphon Tangjitprom   [ updated Jul 12, 2013, 10:26 PM ]
This is summarized from the paper published in Journal of Finance and Investment Analysis by Nopphon Tangjitprom in 2012.

Marketing timing is one of active investment strategies where investors try to adapt their investment positions in order to take advantages of different stock performance in different time. One of important factor to do it successfully is the signal. There are many indicators used as the signal that investors should change their investment positions to take advantages of market condition. One of popular indicator is GEYR or gilt-equity yield ratio. This is the ratio between government bond yield (gilt yield as popular use in United Kingdom) and equity dividend yield. If GEYR is high, it is the signal that the stock market is overvalued compared to bond market and investor should switch to hold bonds. If GEYR is low, it is the signal that the stock market is undervalued and investor should switch to hold stocks. However, in order to use GEYR as the signal indicator, we need the model to predict future trend correctly. 

From the paper, three trading rules are developed. The first trading rule use the lag data of GEYR to predit the equity return in the future. Therefore, investors will switch to hold the stocks if the predicted equity return is higher than government bond yield. The second trading rule use GEYR and other economics variables like term premium and dividend yields to predict future equity excess return, which is the difference between equity return and government bond yield. If the predicted excess equity return is positive, investors should switch to hold the stocks. The third trading rule use Markov Switching model to predict the future GEYR based on the assumption that there are two regimes, high GEYR and low GEYR. If the marginal probability of regime switching is more likely that the GEYR will switch from high-GEYR to low-GEYR regime, investors should switch to hold the stocks. 

The results have revealed that all trading rules can outperform a simple buy-and-hold equity-only portfolio. However, switching strategy requires higher transaction costs because investors need to trade frequently. After including transaction costs the performance from switching strategy is still higher than buy-and-hold strategy. The performance is compared based on mean-variance framework and Sharpe's ratio. 

Moreover, in order to examine the applicability of the trading rules in investment management industries (mutual funds), a set of restriction needs to be considered. For example, Equity fund (equity only mutual fund) needs to hold equity securities at least 65% of total portfolio at anytime. If the signal from trading rule shows that equity should be invested, equity fund can invest all of portfolio in equity securities. However, if signal from trading rule suggests that bond should be invested, equity fund can invest only 35% of portfolio in government securities and still needs to hold 65% in equity securities. This restriction can reduce the performance of switching strategy significantly. However, the result from the paper shows that the switching portfolio still outperforms a simply buy-and-hold portfolio. 

You can read the full article from here