Swedroe: Published Results Impact Future Results

October 24, 2016

Further Evidence

What Calluzzo, Moneta and Topaloglu found is consistent with research from R. David McLean and Jeffrey Pontiff, authors of the January 2016 study “Does Academic Research Destroy Stock Return Predictability?” McLean and Pontiff re-examined 97 factors that had been published in tier-one academic journals and were only able to replicate the reported results for 85 of them. That the remaining 12 factors were no longer significant could be due to a variety of reasons, such as incomplete details in the original paper or changes in databases.

They also found that, following publication, the average factor’s return decays by about 32%. Note the agreement of that figure with the one found in the Calluzzo, Moneta and Topaloglu paper discussed earlier, and that returns don’t decay to zero, but remain positive.

In addition, the authors found factor-based portfolios containing stocks that are costlier to arbitrage decline less post-publication. This is consistent with the idea that costs limit arbitrage and protect mispricing. As the authors note: “Decay as opposed to disappearance will occur if frictions prevent arbitrageurs from fully eliminating mispricing.” They also found that “strategies concentrated in stocks that are more costly to arbitrage have higher expected returns post-publication. Arbitrageurs should pursue trading strategies with the highest after-cost returns, so these results are consistent with the idea that publication attracts sophisticated investors.”

Two conclusions can be drawn from this research. First, anomalies can persist even when they become well-known. McLean and Pontiff write: “We can reject the hypothesis that return predictability disappears entirely, and we can also reject the hypothesis that post-publication return predictability does not change.”

Second, research does appear to lead to increased cash flows from investors seeking to gain exposure to the premiums, which in turn leads to lower future realized returns. However, note that where logical, risk-based explanations exist, premiums should never disappear. For example, no one expects the market beta premium to disappear even though it has been well-known for decades. However, investors shouldn’t automatically assume that future premiums will be as large as the historical record.

 

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