This study examines whether the short-term variation in the Japanese size and value premium is sufficiently predictable to be exploited by a timing strategy. In the spirit of Pesaran and Timmermann [J. Finance 50 (1995) 1201], we employ a dynamic modeling approach in which we explicitly allow for permutations among the determinants in order to mitigate typical data-snooping biases. Using a base set of candidate regressors, we perform an in-sample estimation of all economically sensible models. Subsequently, a "best" model is determined according to a selection criterion. However, whereas most studies use in-sample model selection criteria, we introduce an out-of-sample training period to select our models. We then implement our strategy in a second-stage out-of-sample period: the trading period. All stages re-occur on a monthly basis via a rolling window framework. The results confirm sufficient predictability under lower transaction cost levels. Under high transaction costs scenarios it is more difficult to obtain incremental benefits.

Model selection, Recursive modeling, Size (value) premium, Style rotation
dx.doi.org/10.1016/j.pacfin.2003.10.003, hdl.handle.net/1765/68724
Pacific Basin Finance Journal
Erasmus Research Institute of Management

Bauer, R, Derwall, J, & Molenaar, R. (2004). The real-time predictability of the size and value premium in Japan. Pacific Basin Finance Journal, 12(5), 503–523. doi:10.1016/j.pacfin.2003.10.003