Abstract: In this paper, we propose a trend factor to capture cross-section stock price trends. Stronger trends are likely when firms are experiencing some persistent and fundamental changes. Following traders and investors in practice, we use simple moving averages to measure trends. Like the popular size, book-to-market or momentum factor, our trend factor is a spread portfolio of buying stocks with the highest expected returns as forecasted by trends and selling those with the lowest forecasted expected returns. We find that the trend factor earns a risk-adjusted 3% return per month, more than tripling that of the size, book-to-market and momentum factors. The trend factor has more than five times the Sharpe ratio of the market, and, during the recent financial crisis, it earns 2.88% per month while the momentum factor loses 0.46% per month. The trend factor return is robust to a variety of control variables including size, price, book-to-market, idiosyncratic volatility, liquidity, etc, and is much higher under greater information uncertainty. Moreover, the trend factor explains well the cross-section portfolio returns sorted by short-term reversal and various price ratios (e.g. E/P) as well as industry portfolios, and performs much better than the momentum factor.
Guofu Zhou
Bio sketch: Guofu Zhou is Frederick Bierman and James E. Spears Professor of Finance at Olin Business School ofWashington University in St. Louis, USA. He has a BS degree from Chengdu College of Geology, China, in 1982, and a PhD in economics from Duke University in 1990. Prior to his PhD studies, he was interested in mathematics with publications in number theory, function theory and numerical solutions to partial differential equations. His research interests are primarily in asset pricing and investments. He has published numerous papers in Journal of Financial Economics, Review of Financial Studies, Journal of Financial and Quantitative Analysis, and Journal of Finance, as well as in industry journals such as Journal of Portfolio Management and Financial Analyst Journal. He has won rewards for teaching MBA and MS Fin students and for conducting research. He has consulted for both private firms and government institutions. He is currently on the editorial boards of Journal of Financial and Quantitative Analysis, Journal of Portfolio Management and International Journal of Portfolio Analysis & Management.
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