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Price is What You Pay, Value is What You Get - Dissecting the Quality Anomaly in US Equity Returns

Düsing, Filip LU and Ivarsson, Erik LU (2017) NEKN01 20171
Department of Economics
Abstract
The purpose of the thesis relates to the Quality anomaly observed in the US equity market, where stocks with Quality characteristics tend to outperform and have higher risk adjusted returns. By dissecting the Quality anomaly, the thesis aims to analyze the drivers of the over performance of Quality and investigate the presence of a systematic Quality premium. From previous research, three areas have been identified as theoretical gaps – the magnitude of selection bias, how quality performs during different market conditions and if Quality has explanatory power in a cross sectional setting. By forming an aggregated, zero-investment Quality portfolio, regress it on traditional factor models, analyze condition Beta and perform a Fama Macbeth... (More)
The purpose of the thesis relates to the Quality anomaly observed in the US equity market, where stocks with Quality characteristics tend to outperform and have higher risk adjusted returns. By dissecting the Quality anomaly, the thesis aims to analyze the drivers of the over performance of Quality and investigate the presence of a systematic Quality premium. From previous research, three areas have been identified as theoretical gaps – the magnitude of selection bias, how quality performs during different market conditions and if Quality has explanatory power in a cross sectional setting. By forming an aggregated, zero-investment Quality portfolio, regress it on traditional factor models, analyze condition Beta and perform a Fama Macbeth Cross Sectional Regression, the thesis aspires to address these gaps. Four main conclusions were brought to light;
(i) The lack of a coherent definition of the Quality factor impose selection bias;
(ii) There are tendencies towards flight to Quality – the risk-adjusted returns in excess of the market is mainly generated in down markets and over longer periods;
(iii) The presence of a Quality premium is observed. When regressed on multifactor models, the Quality portfolio generates monthly significant alpha in between 0.431 - 0.549 %. Furthermore, the Quality portfolio loads significantly negative on market Beta, and tendencies are observed on significant negative factor loadings on SMB and HML. Thus, traditional factor models cannot explain the Quality premium.
(iv) The premium appears to be caused by systematic errors rather than exposure to a systematic source of risk, as the Quality anomaly becomes evident first during longer time periods or during crises. In a CSR, Quality cannot be rejected to improve the model, but as such, it is also concluded not to be a compensation for carrying a systematic risk premium. (Less)
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author
Düsing, Filip LU and Ivarsson, Erik LU
supervisor
organization
course
NEKN01 20171
year
type
H1 - Master's Degree (One Year)
subject
keywords
Factor Investing, Quality Factor, Quality Screen, Cross Sectional Regression, Conditional Beta Analysis, Selection Bias
language
English
id
8923958
date added to LUP
2017-09-12 11:54:31
date last changed
2017-09-12 11:54:31
@misc{8923958,
  abstract     = {The purpose of the thesis relates to the Quality anomaly observed in the US equity market, where stocks with Quality characteristics tend to outperform and have higher risk adjusted returns. By dissecting the Quality anomaly, the thesis aims to analyze the drivers of the over performance of Quality and investigate the presence of a systematic Quality premium. From previous research, three areas have been identified as theoretical gaps – the magnitude of selection bias, how quality performs during different market conditions and if Quality has explanatory power in a cross sectional setting. By forming an aggregated, zero-investment Quality portfolio, regress it on traditional factor models, analyze condition Beta and perform a Fama Macbeth Cross Sectional Regression, the thesis aspires to address these gaps. Four main conclusions were brought to light;
(i) The lack of a coherent definition of the Quality factor impose selection bias; 
(ii) There are tendencies towards flight to Quality – the risk-adjusted returns in excess of the market is mainly generated in down markets and over longer periods; 
(iii) The presence of a Quality premium is observed. When regressed on multifactor models, the Quality portfolio generates monthly significant alpha in between 0.431 - 0.549 %. Furthermore, the Quality portfolio loads significantly negative on market Beta, and tendencies are observed on significant negative factor loadings on SMB and HML. Thus, traditional factor models cannot explain the Quality premium. 
(iv) The premium appears to be caused by systematic errors rather than exposure to a systematic source of risk, as the Quality anomaly becomes evident first during longer time periods or during crises. In a CSR, Quality cannot be rejected to improve the model, but as such, it is also concluded not to be a compensation for carrying a systematic risk premium.},
  author       = {Düsing, Filip and Ivarsson, Erik},
  keyword      = {Factor Investing,Quality Factor,Quality Screen,Cross Sectional Regression,Conditional Beta Analysis,Selection Bias},
  language     = {eng},
  note         = {Student Paper},
  title        = {Price is What You Pay, Value is What You Get - Dissecting the Quality Anomaly in US Equity Returns},
  year         = {2017},
}