Value and momentum portfolios on the Johannesburg Stock Exchange

Abstract

The existence and persistence of the mean reversion and value effects on equity markets suggest that it may be possible to use these phenomena to identity commercially exploitable arbitrage opportunities. This research attempted to capitalise on such irrational investor behaviour on the Johannesburg Stock Exchange by developing market-beating trading strategies founded on the theories of mean reversion and value investing, both individually and in combination. Historical share price, dividend payouts, price-to-earnings and book-to-market data were used to generate test portfolios that were optimised in terms of excess returns over the three variables formation period, holding period and portfolio size. The results of the optimisation simulations revealed significant opportunities to generate market-beating returns for all trading strategies tested. Mean reversion trading strategies were shown to outperform price-to-earnings and book-to-market strategies. The incorporation of price-to-earnings and book-to-market constraints into the mean reversion strategies proved to reduce the effectiveness of those strategies.