Financial Education

In the March/April 2007 Financial Analysts Journal, Desrossiers, Lemaire and L’Her examine whether the residual income model is useful in predicting the relative returns for developed country indices. Zero-investment strategies (long the countries with the highest residual income and short those with the lowest) posted significant positive performance over various holding periods during the sample period 1988-2005.

These returns remained significant after adjusting for factors such as market, size, book-market ratio and momentum. They were also robust to various long-term growth estimates, different country-universe subsamples and transaction costs. Average monthly excess returns from the long-short strategy ranged from 0.47% to 0.67% depending on time horizon and optimization strategy, and all were significant at the 5% level.

The results suggest investors may be better off allocating assets to attractively-valued markets rather than adopting a passive asset allocation approach.

For more information, see all articles on: Asset Allocation, Research, Security Selection, Valuation

See also:

The Residual Income Valuation Model

Best and Worst Situations for Applying Residual Income Models

Strengths and Weaknesses of the Residual Income Model

Residual Income

The Top Down Approach to Security Selection