Working Paper: CEPR ID: DP2180
Authors: Jimmy Liew; Maria Vassalou
Abstract: We examine the extent to which the profitability of the HML, SMB, and WML trading strategies can be linked to future GDP growth. Using a large cross-section of securities from ten developed markets, we find that the HML and SMB portfolios contain significant information about future GDP growth. The predictive ability of these strategies is to a large degree independent of any information contained in the domestic market factor, which is known to be a leading indicator of economic growth. Even in the presence of popular business cycle variables, HML and SMB retain their ability to predict future economic growth in some of the countries examined. Our results support a risk-based explanation for the performance of the HML and SMB trading strategies. Little evidence was found to support such an explanation in the case of the WML trading strategy.
Keywords: book-to-market; size; momentum; trading strategies; GDP growth
JEL Codes: G11; G12; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| HML (Y20) | future GDP growth (O49) |
| SMB (Y90) | future GDP growth (O49) |
| low returns from HML (G19) | low future GDP growth (O49) |
| low returns from SMB (G19) | low future GDP growth (O49) |
| HML and SMB (C39) | future GDP growth (O49) |
| HML independent of market factor (G19) | future GDP growth (O49) |
| SMB independent of market factor (G19) | future GDP growth (O49) |
| WML (Y20) | future GDP growth (O49) |