Macroeconomic Determinants of Cyclical Variations in Value, Size and Momentum Premiums in the UK

Abstract

The paper examines the asymmetries in size, value and momentum premiums over the economic cycles in the UK and their macroeconomic determinants. Using Markov switching approach we find clear evidence of cyclical variations of the three premiums, most noticeably variations in size premium. We associate Markov switching regime 1 with economic upturn and regime 2 with economic downturn. The macroeconomic indicators prompting such cyclicality the most are growth in industrial production, term structure, credit spread and money supply. Using forecast returns from our model and a trading strategy that alternates between size/style/momentum portfolios and risk-free rate, we show that exploiting cyclicality in premiums proves particularly profitable for portfolios featuring small cap stocks in recessions. JEL classification: G11, E32