Utilizing Momentum Trading Strategy on the UK Stock Market: Challenging Efficient Market Hypothesis
A number of studies have illustrated that stock returns may be predictable through implementing a momentum trading strategy, which contradicts the whole concept of the Efficient Market Hypothesis. This paper will discuss the Efficient Market Hypothesis and focus on its challenges in the face of behavioral finance. In addition, empirical research is conducted to test whether a momentum strategy can be implemented to successfully beat the market.
This dissertation draws on the framework developed by Jegadeesh & Titman (1993), while also taking ideas from other relevant scholars in the field, and analyses the monthly returns generated from the momentum strategy used, examining whether the returns in each constructed portfolio is greater than the return of the UK stock market (FTSE All-Share market index) for the period 2016, based around Brexit, an event which had an influence on the stock market as a whole, and construct another set of portfolios one-year prior to the event, to act as a control for comparability and to test validity of the momentum strategy being used to generate excess returns.
From the empirical data, it is seen that in the Brexit portfolios, every portfolio beat the market, however for the pre-Brexit portfolio, a few portfolios under performed the market, with the majority beating the market. Although the two time periods tested had dissimilar results, this dissertation can still confirm that the use of the momentum strategy can be used to predict future returns, and manage to earn abnormal returns.
This dissertation is inspired by the desire to gain a greater understanding of the financial markets, through implementing momentum trading strategies and examining anomalies to exploit any market inefficiencies. The research is motivated by a strong personal interest in the general topic areas and perceived gaps in existing literature. Moreover, financial market efficiency is the central importance to practitioners, investors, corporations and regulators, with financial theory being based around the belief that financial agents and markets are rational.
Furthermore, investors depend greatly on strategies which observe stock market behaviour, a key focus of this research. Also, with the continuous success of individuals such as George Soros and Warren Buffett, they represent the most immutable contradiction of market efficiency theories, that returns are unpredictable.
Momentum Trading Strategy Dissertation
Background to the study
Importance of the study
Structure of the dissertation
2: Literature Review
An introduction to the Efficient Market Hypothesis (EMH)
Testing the efficient market hypothesis
Testing the weak-form efficiency
The Filter approach
The Dow Theory
Testing the semi-strong form efficiency
Testing the strong-form efficiency
The calendar effect
The January effect
Under-reactions, over-reactions and contrarian strategy
Time period to test
The United Kingdom’s withdrawal from the European Union (Brexit)
One year prior to United Kingdom’s withdrawal from the European Union (pre-Brexit)
Formation Period and Holding Period returns
The Zero-Cost Trading Strategy
Null Hypothesis (H0)
Alternative Hypothesis (H1)
4: Results and Analysis
Results for 3-months formation period
Results for 6-months formation period
Results for 9-months formation period
Results for 12-months formation period
Testing the validity of the research results
The January Effect
Effect of the EU Referendum on the test results
Summary of research results
Limitations of the study and suggestions for further research
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Capital Structure and Corporate Decision Making: The Role of Compensation Plans on Managerial Decisions in Relation to Stock Performance in the Financial Markets
This dissertation attempts to answer the research question as to whether compensation plans provide better incentives for managers to take risks and increase stock performance in financial markets by corporations. Objectives aimed at examining whether compensation plans influenced managerial decisions and overall future stock performance in corporations. Another objective assessed effectiveness of compensation plans towards managerial risky decisions and performance. The author’s central argument was that compensation arrangements and efficient market information functionality motivated managerial decisions that increased future stock performance in corporations. The research methods adopted comprised of qualitative research methods that linked past evidence, theories and research works by other scholars to reaffirm or refute previous theories.
The methodology maintained an empiricist paradigm and research that made sense through objectivity realised from collected data. The models sought explanations and predictions with an aim of confirming, or substantiating relationships, as well as assembling generalisations on theoretical frameworks. Qualitatively, trends, gaps and opportunities were critically examined using desktop appraisal of secondary literature, documents, journals, books and reports. Content analysis method detailed systematic assessment of substances in specific materials aimed at identifying patterns, themes, or biases.
The review finds consistent literature to demonstrate that indeed compensation arrangements contribute to performance by managers. Organizations that link compensation plans with individuals could attract egoistic kind of CEO. Extrinsic incentives, particularly money, correlated with the largest productivity in terms of stock performances. Skills-based compensation plan now forms the new trend when identifying potential CEOs. Additionally, when designing compensation arrangements, one should balance with conflicting objectives by the shareholders, executives and corporations. What worked for firm A cannot be assumed to work for firm B because each corporation is distinct in size, philosophy, values and objectives.
To examine whether compensation plans influence managerial decisions and overall stock performance in corporations
To assess effectiveness of compensation plans towards managerial risky decisions and performance
1 – Introduction
Statement of the Problem
2 – Literature Review
Does Compensation Plan and Risky Decision Taking Translate to Better Performance?
The Role of Financial Markets in Managerial Decision Making
Forms of Compensation Plans
Effectiveness of Compensation Plans, Risky Managerial Decisions and Performance
3 – Research Methodology
4 – Research Findings
The Hard Facts
Why Compensation arrangements and Performance Metrics?
Short and Long-term Bonus Measures
Human Resource Methods
The Bogey Plan
Relative Performance Evaluation (RPE)
Informational Function of Managerial Decision Making by Financial Markets
The Correlation between Compensation Plans, Risky Decision Making and Performance
Reasons for compensation plans
Reasons against compensation plans
Compensation arrangements and its Effectiveness towards Performance
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Over the past few decades, the global scenario has changed considerably with increased interdependence amongst nations and economies. This intertwining amongst nations and sharing of ideas and technology has been termed as “Globalization”. Globalization has been a buzzword of late, with heated discussions about its pros and cons. Some consider it to be a blessing for mankind while others take it as a curse. For some it has brought about material prosperity while others have become unemployed due to it. This paper tries to analyse the effect of Increased International Trade and Globalisation on the US economy. The first section discusses the pros and cons of Globalization while the second section discusses how globalization has lead to increased foreign trade. Thereafter, it discusses the effect of globalisation and increased foreign trade on the American economy.
Trade is believed to have taken place throughout much of recorded human history, whether as barter or in exchange of currency. Till the 1800’s, trade was limited due to difficulties in transportation, communication and restrictive trade policies. However, in the mid 19th century, with advent of free trade and nation advantage concepts, trade started to pick up (Daniels & Sullivan, International Business and Operation). Although international trade has been present throughout much of history, for example Silk Route, its economic, social, and political importance have increased in recent centuries, mainly because of Industrialization, advanced transportation, globalization, multinational corporations, and outsourcing. Worldwide, countries are doing away with trade restrictions and lowering trade tariffs, thereby supporting free trade and making the world a global village (Daniels & Sullivan, International Business and Operation).
Globalization – Boon or Bane
The global economy is no longer an individual event and USA no longer plays the dominating role. This is apparent from the fact that ten years ago the World Trade Organization had only 80 members whereas now it has 153 members (WTO Data, 2010). Also countries like China and India are getting more bargaining power day by day. Globalization is the deepening relationship and broadening interdependence amongst the different countries of the world. The World Bank defines globalization as “the growing integration of economies and societies around the world.” This integration of regional economies into a global village has lead to increased international trade, investment, capital flows and technological advancements. Technological advancements such as the internet and cell phones have literally reduced the world to a Global village. Globalization has both its critics and it supporters. Some interpret it as a way of countries losing their cultural identities and becoming “Americanized.” Others see it as a way to reduce costs and to increase profits and efficiency. The debate over globalization is perceptible in demonstrations against the WTO in Seattle in the fall of 1999, against the Summit meetings in Quebec and Genoa and against several annual meetings of the IMF and World Bank. While on the other hand, supporters of globalisation look forward to a global village, linked together by the Internet, and enjoy the ever-increasing material well being (Daniels & Sullivan, International Business and Operation). The United States is seen by much of the world as the strongest supporter of globalization – in fact, as pushing it on everyone else. Over the years, globalization has resulted in increased foreign trade and capital flows, thereby contributing immensely to the domestic economy. In the 1990s, globalization and free trade, resulted in integration of China and the former Soviet bloc into the trading system thereby lowering inflation and opening new markets. However, as the emerging markets got stronger, the prices of commodities started rising immensely and competition from foreign workers lowered the average US wage rates. Jeffrey Garten, professor of international trade and finance at the Yale School of Management, points out that in 2000, the world’s wealthiest countries accounted for about 70 percent of the global economy, compared with 30 percent for developing economies. These rates are slowly but surely reversing. Thus, USA has seen both the positives and the negatives of globalization.
One important effect of globalization is the increased interdependence among nations which has demanded increased liberalization of markets, the dismantling of almost all trade barriers (Lee, 2005; Czinkota and Ronkainen, 2007). As a result, the forces of globalization have necessitated trade liberalization (Martin, 1993), leading to increased international trade, not only in good and services but also currency and capital. Ever since independence, America has been a supporter of Free Trade. In 1988, USA signed a Free Trade Agreement with Canada that progressively eliminated tariffs over a ten‐year period, thereby making Canada USA’s premier trading partner. Further, in 1994 the Mexican Government, in pursuit of market reforms, signed the North American Free Trade Agreement (NAFTA). The passage of the NAFTA agreement signalled the continuing support of U.S. policy‐makers for the worldwide march toward free markets and further economic globalization (Paul. S Boyer, 2001). The above agreements lead to immense increase in trade and greater market efficiency. However, by 1999 USA had a huge trade deficit of around USD 200 billion (Paul. S Boyer, 2001). The trade boom of the 1990’s had ended in a recession marked by serious job losses and the nations policy of “free trade” was being questioned. President George W. Bush insisted that America’s economic future lay with the global economy, but early in 2002 political pressures led him to slap import duties on cheap foreign steel. However, he was forced to withdraw it in 2003 due to retaliation against US exports and WTO sanctions (Paul. S Boyer, 2001)
Competition and Business Restructuring
International competition goes hand-in-hand with globalization. A company that has been very successful in the domestic market may suddenly find itself facing competition from a yet unheard of company from the other end of the globe. Survival in this new business environment calls for improved productivity, reduction in costs, up gradation in technology and advancements in supply chain management (O’Reilly, E., & Alfred, Diane., 1998). For example, In the 1980s American automobile manufacturers began losing market share to Japanese competitors who offered American consumers higher quality cars at lower prices (Brewer, G., Managerial Accounting). However, from the consumer’s point of view, increased competition promises greater quality, reduced prices and a greater variety of goods and services. China’s entrance into the global marketplace has proved that globalisation leads to competition and changes the business environment. For example, from 2000 to 2003, China’s wooden bedroom furniture exports to the United States increased by more than 233% to a total of $1.2 billion. During this same time, the number of workers employed by U.S. furniture manufacturers dropped by about a third, or a total of 35,000 workers (Fishman, T., 2005).
In a 2002 speech, the Economic counsellor to the US Embassy, Mr Lee Brudvig, said, “We have not resisted the free flow of money, goods, services, and ideas. Rather, we have subjected our companies to market competition and limited the role of government on the whole to that of facilitator, regulator and, when necessary, safety net provider. As a result, we have seen a massive reorganization of business structures. Whereas in 1960 manufacturing accounted for 27 percent of GNP, by 2001 it had dropped to below 15 percent.” The changes brought about by technology and productivity is causing both markets as well as organisations to undergo restructuring.
Labour Market Developments
An important trend in labour markets in the advanced economies has been a steady shift in demand away from the less skilled toward the more skilled (Slaughter, M., & Swagel, Philip., 1997). Studies have shown, for the advanced economies as a whole, that trade with developing countries has led to about a 20 percent decline in the demand for labour in manufacturing, with the decline concentrated among unskilled workers (Swagel, Philip., 1997). This trend has produced dramatic rises in wage and income inequality between the more and the less skilled. In the United states, wages of less-skilled workers have fallen steeply since the late 1970s relative to those of the more skilled (Slaughter, M., & Swagel, Philip., 1997). According to a study conducted in 2007, the impact of trade flows in 2006 increased the inequality of earnings by roughly 7% (Bivens,J., 2007). The study goes on to prove that although “liberalized trade” is a win-win proposition for nations, it reduces the income of most workers. Workers employed in industries directly in competition with low-cost imports from abroad can expect to see immediate job dislocation and/or downward wage pressures.
The rise of labour abundant nations, like China and India, has increased the global labour pool. The price of labour-intensive commodities falls as a result of this increase in the global labour pool, and these falling prices harms the labour in professional-abundant nations like the United States. DVD Players, clothing and call centre operations, all provide examples of reduction in prices due to expansion in the global labour pool (Slaughter, M., & Swagel, Philip., 1997). Outsourcing and offshoring, has further increased unemployment and decreased national earnings. 22-29% of the U.S. workforce has been rated as potentially offshorable over the next one or two decades (Blinder, 2006). The implied loss due to offshoring would push these wages well below the 1979 levels, completely undoing the entire increase in these wages over the past three decades. The trade adjustment assistance (TAA) program has been formed as a way to compensate globalization’s victims in the United States. In 2006 TAA allocated $655 million in income supports for workers harmed by globalization, and, another $200 million for training. As quoted by Bradford, Grieco, and Hufbauer in their study, “While the gains from increased trade generate a permanent rise in income, the associated losses are temporary. Nevertheless, they are very real, and are concentrated on a small fraction of Americans”.
Financial Market Globalisation
Financial globalization has been one of the most important trends in the world economy in recent decades. Financial globalization has been one of the most important trends in the world economy in recent decades (Lane and Milesi-Ferretti 2003). International financial liberalization was also accompanied, in a
somewhat chicken-and-egg causal relationship, by the abandonment of the Bretton Woods system of adjustable exchange rate pegs and the shift to floating exchange rates among the major currencies or regional currency blocs (Eatwell 1996). When currency fluctuations are considered, it is the exchange rate between the US dollar and the euro that gets the most attention. This not only reflects the size of the respective economies using these two currencies, but also the fact that the US dollar is the most widely traded currency today. That’s because it effectively serves multiple roles: as an investment currency; as a reserve currency for many central banks. According to an IFSL research conducted in April 2007, the US dollar was involved in 86% of foreign exchange transactions, followed by the euro (37%), which proves its importance (Safar, L., 2008). The report further states that foreign currency trading increased by 70% in 2008 compared to 2004. This increase in currency trading makes it imperative for companies to learn to deal with exchange fluctuations and how to benefit from all situations. The US dollar has fallen since January 2004 against the euro as well as against most major European and Asian currencies. This has caused many companies to introduce a “fluctuation clause” in their contracts to protect themselves from losses due to exchange rate fluctuations and has also lead to the development of many financial instruments to help companies hedge their currency risks. However, times such as these when the dollar becomes weaker often works well for US producers with a larger proportion of their costs being in dollars but selling worldwide. International revenues not only translate to higher US-denominated revenues, but they also contribute to higher margins which can be achieved globally (Safar, L., 2008). For example, Q1 2008 for instance marked a milestone for Google, whose international revenues exceeded US revenues for the first time. Revenues from outside of the United States represented 51% of total revenues in the period, compared to 47% in the first quarter of 2007 and 48% in the fourth quarter of 2007. In Q2 2008, this had increased further to 52%. According to Google, “Had foreign exchange rates remained constant from the second quarter of 2007 through the second quarter of 2008, our revenues in the second quarter of 2008 would have been $249 million lower.” (Safar, L., 2008). Nothing can be predicted with 100% accuracy when it comes to exchange rates, and the only thing that can be safely said is that there will be no “business as usual” when it comes to currencies.
Political and Institutional Changes
According to CIA Global Trends 2015, 2000,” The rising tide of the global economy will create many economic winners, but it will not lift all boat. It will spawn conflicts at home and abroad, ensuring an even wider gap between regional winners and losers than exists today. Regions, countries and groups left behind will face deepening economic stagnation, political instability and cultural alienation. They will foster political, ethnic, ideological, and religious extremism, along with the violence that often accompanies it.” One of the most important and necessary features of the current process of globalization is the proliferation of international organizations. Scholars point to the emergence of expanding web of international treaties and institutions, which regulate and adjudicate on matters of interstate behaviour. The number of international organizations rose from 61 in 1940 to 260 by 1996 (Barnett 2002:110). Since 1995, when the World Trade Organization (WTO) was formed, transnational corporations have increasingly influenced political leaders to push international trade laws in the same direction of liberalization and deregulation. In addition, existing international organizations like the IMF, the World Bank and the GATT/WTO have transformed their roles substantively, gaining further powers and responsibilities (Camillery and Falk 1992:94-7; O’Brien et al. 2000). The United States has enjoyed a position of power among the world powers, in part because of its strong and wealthy economy. Due to this reason, the United States enjoys considerable bargaining powers in the WTO and World Bank. With the influence of globalization and with the help of The United States’ own economy, the People’s Republic of China has experienced some tremendous growth within the past decade, and now enjoys as much bargaining power, if not more, as USA. If China continues to grow at the rate projected by the trends, then it is very likely that in the next twenty years, there will be a major reallocation of power among the world leaders. China will have enough wealth, industry, and technology to rival the United States for the position of leading world power (Fishman, T., 2005).
Crime and Terrorism
At the end of the 20th century, a new phenomenon appeared—the simultaneous globalization of crime, terror, and corruption, an “unholy trinity” that manifests itself all over the world. This unholy trinity is more complex, however, than terrorists simply turning to crime to support their activities or merely the increased flow of illicit goods internationally. Rather, it is a distinct phenomenon in which globalized crime networks work with terrorists and both are able to carry out their activities successfully, aided by endemic corruption. Crime groups and terrorists have exploited the enormous decline in regulations, the lessened border controls, and the resultant greater freedom, to expand their activities across borders and to new regions of the world. The United States has been one of the worst sufferers of this new “global” terrorism. Since September 11, 2001, numerous resources have been shifted in the United States and elsewhere from addressing trans-national crime to fighting terrorism. It has increasingly become clear, that for a nation to advance, it has to keep its crime and terror activities in check.
Cultural and Other Issues
The growth of cross-cultural contacts has helped the United States participate in a new World Culture. It has helped Hollywood reach remote corners of the world while at the same time Bollywood has reached out to the Americans. Globalization has also lead to greater international travel and tourism thus greatly benefiting the tourism industry. WHO estimates that up to 500,000 people are on planes at any one time. (WHO Data, 2009). In 2008, there were over 922 million international tourist arrivals, with a growth of 1.9% as compared to 2007 (UNTWO Data, 2009). Globalization has also increased the number of illegal immigrants entering USA. The Rockridge Institute argues that globalization and trade agreements affected international migration, as laborers moved to where they could find jobs. The Mexican government failed to make promised investments of billions of dollars in roads, schooling, sanitation, housing, and other infrastructure to accommodate the new maquiladoras (border factories) envisioned under NAFTA. The 1994 economic crisis in Mexico, which occurred the year NAFTA came into effect, resulted in a devaluation of the Mexican peso, decreasing the wages of Mexican workers relative to those in the United States. Unemployment, corruption, low wages and few opportunities cause Mexican laborers to look for greener pastures and migrate illegally to the United States.
Globalization leads to increased international trade and reduction in trade barriers, which is beneficial for all the trading nations. Increased globalizartion has increased competition in the global economy, making it tougher for organisations to survive, and leading to greater productivity, efficiency and quality. This has in turn lead to the rise of countries like China and India, which are rich in labour. Due to the rise of labour abundant nations, the US labour market has suffered with fewer jobs being available for unskilled workers and lowering of wages. Further, outsourcing and offshoring have lead to loss of jobs and unemployment. In order to establish a set of trade rules and monitor the trading nations, institutions like WTO, IMF and World Bank have gained in importance. The United States hold a very important place in all these institutes, due to its strong economy and political power. Thus, it has a huge bargaining power when it comes to trade regulations. Overall, globalisation has affected America both positively as well as negatively but it is primarily due to globalisation and increased trade that America has a strong economy today.
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