Does Volatility Allow for Style Rotation? Evidence from International Stock Market Returns

Unlike the existing literature on value and growth investing, this paper takes a different point of view by conducting a "between-markets analysis." First of all, it asks whether the value premium also exists on a country level, in the sense that country indexes that are undervalued consistently outperform country indexes that are overvalued. Second, it is tested whether the possible existence of such a "between-markets" premium is captured by the CAPM model, or whether additional risk factors are necessary to correctly price value and growth portfolios. Third, a trading strategy based on these asset pricing approaches is implemented, in order to study the profitable exploitability of a style rotation strategy that dynamically invests long in either value or growth portfolios, and shorts the other bucket. Contrary to the vast majority of the style rotation literature which uses a broad set of macroeconomic indicators as explanatory factors, this paper solely focuses on volatility, where volatility is derived from a GARCH model. The results suggest that models which account for additional risk factors are better suited to price value and growth portfolios, and that dynamic style rotation strategies are profitably implementable.