Financial Behavior and the Momentum Strategy

University essay from Lunds universitet/Företagsekonomiska institutionen

Abstract: Title: Financial Behavior and the Momentum Strategy Seminar date: 2018-05-31 Course: FEKH89, Bachelor’s Degree Project in Financial Management, Business Administration, Undergraduate Level, 15 ECTS Authors: Emil Eliasson, Olle Josefsson, Fredrik Thörning Advisor: Maria Gårdängen Purpose: The authors of this thesis aim to study if it is possible to generate a better Sharpe ratio within the CAPM-theory using a mathematical model to buy and sell a risky asset depending on the market volatility. The authors then aim to explain the changes in volatility by discussing anomalies in the market. Methodology: In order to fulfill the purpose and to answer the research questions, the methodology of this thesis is heavily based on a mathematical algorithm. The algorithm is set to trade a hypothetic portfolio in order to generate a better result than the index. With primarily the non-traditional theories mentioned below, the result is then compared with the chosen indices. Theoretical perspectives: Theories used in this thesis can be divided into traditional and non-traditional theories in economics. The traditional perspective is represented by the Efficient Market Hypothesis, EMH, and the Capital Asset Pricing model, CAPM. The non-traditional theories are Behavioral Finance and Herd Behavior. Empirical foundation: The empiric analyzed in this thesis is based on the performance of the algorithm and the two indices Dow Jones Industrial Average and Standard and Poor’s 500. The analyzed period is from the beginning of 1998 until the end of 2017. Conclusions: The algorithm is able to gain a better Sharpe ratio than the market index on Standard and Poor’s 500 but not on Dow Jones Industrial Average. The authors found the cause to be an unreasonable high volatility on Dow Jones Industrial Average in the year of 2000 and 2016. This forces the algorithm to execute unnecessary trades and therefore gain a weak return due to transaction costs.

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