Dear Econometrics Expert,
I would like to test the effectiveness relative strength and residual momentum strategy. In the strategy, overall the steps are:
1. sort the stocks to form a portfolio based on the returns (relative strength) and idiosyncratic return (residual) for J months (formation period) chosen. The stocks with the highest value categorized as winner and the ones with the lowest value are categorized as loser.
2. calculate the abnormal return for K months (holding period) in the future.
3. analyze the significance of return from winner minus loser using t statistics.
I'm using the Fama-French 3 factors model to estimate the return which is needed to form a portfolio based on size and book value. The question is:
1. How can I integrate the Fama French 3 Factors Model to the portfolio formation, since it is like double sorting the portfolio?
2. About the J/K months I've chosen, if I used event study to analyze the period as follows:
- 31 Dec 2019 - 1 Mar 2020 (2 months)
- 2 Mar 2020 - 30 Mar 2020 (1 months)
- 31 Mar 2020 - 5 Dec 2020 (8 months)
- 5 Dec 2020 - 28 Feb 2021 (3 months)
may I analyze the effectiveness of the momentum strategy by using the K period (holding) of 2, 1, 8, and 3 respectively for that specific period only?
Thank you very much.
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