How do style factors behave in times of crisis in Europe?

Abstract

Financial crises are not something new, and investors have had to deal with them for decades. Especially in the current situation, in the recovery of Covid-19 and currently hit by the Russian invasion of Ukraine. These various unexpected events directly impact the financial market, and to protect against investors, they must allocate their investments accordingly.

This thesis mainly focused on style factors and how these style factors behave in times of crisis. The following style-based portfolios have been used for the study: market, size, value, momentum, profitability, and investment firm’s strategy. Their exposures to four macroeconomic variables under normal and distressed economic conditions were computed through a rolling window regression to analyze their behavior. The four macroeconomics selected to carry on the analysis are GDP growth, inflation, the unemployment rate, and the term structure, and the whole period under analysis is from 1998 to 2022.

The two economic states are compared regarding exposure to the economic variables. Then an application of the results is applied to a portfolio construction strategy. The portfolio built based on the results obtained outperformed the other in terms of return. The following conclusion can be taken regarding the different style factors. In times of crisis, a short position should be taken for the market and investment factors and a long position for the value, size, momentum, and profitability factors with more substantial exposure to the momentum. We can also highlight that the weight allocation seems to be significantly different for the size and the investment factors between economic turmoil and normal condition.

The conclusion suggests an outperformance based on the results obtained, but this needs to be taken carefully as the statistical significance of the coefficients obtained is weak. Furthermore, at the end of the work, suggestions related to the limitations are made to improve the analysis further.