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Equity investors like to check out a company's price/earnings ratio before they invest in its stock. Likewise, real estate investors should do the same before buying a house. The equivalent of price/earnings ratio for real estate is the price/rent ratio, or inversely, the rent/price yield.
What is a reasonable rent/price yield for US residential real estate? According to Morris Davis of the University of Wisconsin-Madison, and Andreas Lehnert and Robert Martin of the Fed, the long-term average is 5% (i.e. the annual rent of a house should be about 5% of its market value). As the Economist magazine has reported, at the height of the US housing boom, this figure dropped to as low as 3.5%.
Currently, this ratio is at about 4.3%, which implies that average US housing price has to drop another 14% in order to return to its historical fair value.
Can quantitative traders profit from this prediction? Well, we can always short the S&P/Case-Shiller Home Price Indices futures at the Chicago Mercantile Exchange.
A combination momentum and mean reversal model based on earnings annoucements
Mark Hulbert of the New York Times just discussed 2 momentum strategies investigated by professors David Aboody, Brett Trueman and Reuven Lehavy.
Strategy A: pick stocks in the top percentile of 12-month returns. Buy them (individually) 5 days before their earnings announcements and sell them just before the announcement.
Strategy B: pick stocks in the top percentile of 12-month returns. Buy them (individually) 5 days immediately after their earnings announcements and hold them for 5 days.
Strategy A is very profitable: the annualized excess return is 47% before costs. (To be taken with a grain of salt due to the large transaction costs associated with trading momentum strategies, especially if small-cap stocks are involved.) Strategy B is very unprofitable: the annualized excess return is -43% before costs.
So what are the ways we can make best use of this research?
Naturally, instead of buying the top percentile after the earnings announcements, we should have shorted the stocks, thus making Strategy B a reversal strategy instead.
Furthermore, what about the bottom percentile of stocks? Should we have shorted them prior to the announcements, and bought them after the announcements? If so, we would have a very nice dollar-strategy for you statistical arbitrageurs out there!
Strategy A: pick stocks in the top percentile of 12-month returns. Buy them (individually) 5 days before their earnings announcements and sell them just before the announcement.
Strategy B: pick stocks in the top percentile of 12-month returns. Buy them (individually) 5 days immediately after their earnings announcements and hold them for 5 days.
Strategy A is very profitable: the annualized excess return is 47% before costs. (To be taken with a grain of salt due to the large transaction costs associated with trading momentum strategies, especially if small-cap stocks are involved.) Strategy B is very unprofitable: the annualized excess return is -43% before costs.
So what are the ways we can make best use of this research?
Naturally, instead of buying the top percentile after the earnings announcements, we should have shorted the stocks, thus making Strategy B a reversal strategy instead.
Furthermore, what about the bottom percentile of stocks? Should we have shorted them prior to the announcements, and bought them after the announcements? If so, we would have a very nice dollar-strategy for you statistical arbitrageurs out there!
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