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The Evidence of the Value Premium, the Size
Effect, and Momentum versus Contrarian

Strategies in Indonesian Stock Market

Master Thesis

Faculty of Economics and Business Administration
Master of Science in Financial Economics
Track: Financial Analysis
Author: Dwi Astuti Putranto , i588733
Supervisor: Dr. Jeroen Derwall
Co-Supervisor: Dr. Marco Avarucci

Dwi Astuti Putranto, The Evidence of The Value Premium, The
Size Effect, and Momentum versus Contrarian Strategies in
Indonesian Stock Market

2

Contents

Abstract ....................................................................................................................... 7
I. Introduction ............................................................................................................. 8
II. Literature Review ................................................................................................ 13
1. The traditional CAPM .................................................................................... 13
2. The value premium .......................................................................................... 17
2.1 Evidence in U.S. Market........................................................................... 17
2.2 Evidence in International Markets ......................................................... 18
2.3 Evidence in Asian Markets ...................................................................... 18
3. The size effect ................................................................................................... 22
4. Momentum versus contratrian strategies ..................................................... 23
4.1 The evidences of momentum versus contrarian strategies in U.S.
Market .............................................................................................................. 24
4.2 Asymmetric reactions to good news as opposed to bad news ............... 25
4.3 Trading volume and momentum versus contrarian strategies ............. 26
4.4 The Sources of momentum and contrarian profits ................................ 26
III. Data Analysis...................................................................................................... 31
1. Indonesia Stock Exchange .............................................................................. 31
2. Data ................................................................................................................... 31
3. Methodology ..................................................................................................... 33
4. Time-series return regression ......................................................................... 39
5. The GRS Test ................................................................................................... 43
IV. Result ................................................................................................................... 46
1. Simple glamour and value strategies .................................................................. 46
2. Two-independent sort glamour and value strategies ........................................ 48
3. The size effect ........................................................................................................ 51
4. Momentum versus contrarian strategies............................................................ 52
5. The effect of trading volume on momentum/contrarian profits ...................... 53
V. Robustness Check ................................................................................................ 55
1. The Simple CAPM time-series regressions ........................................................ 55

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2. The Fama French three-factor model ................................................................ 58
3. The post-crisis analysis of the value premium ................................................... 62
4. Jegadeesh and Titman methodology of momentum versus contrarian
strategies .................................................................................................................... 63
5. The post-crisis analysis of Jegadesh and Titman methodology for momentum
versus contrarian strategies ..................................................................................... 65
VI. Conclusions ......................................................................................................... 66
References ................................................................................................................. 68
Text Figures .............................................................................................................. 76
Text Tables ................................................................................................................ 78


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List of Figures

Figure 1 The Risk Return Tradeoff ............................................................... 76
Figure 2 Jakarta Composite Index and Capital Market Milestones 1984-
June 2008 ........................................................................................... 77


5

List of Tables

Table I The Complete Overview of All Variables ....................................... 78
Table II Trading Value on Indonesian Stock Market .................................. 79
Table III Returns for Quintiles Portfolios Based on One-Dimensional
Classification by Various Measures of Value Characteristics ...... 79
Table IV Returns for Portfolios Based on Two-Dimensional Classifications
by Various Measures of Value Characteristics .............................. 80
Table V Returns for Portfolios Based on Size-Classifications .................... 82
Table VI An Overlapping Momentum/Contrarian Average Monthly Returns
of JKSE Stocks: 12/1991-12/2008 using Lo and MacKinlay (1990)
Methodology ...................................................................................... 82
Table VII Momentum/Contrarian Average Returns using Lo and MacKinlay
(1990) Methodology that Incorporates Trading Volume .............. 83
Table VIII The CAPM Time-Series Regressions for Monthly Excess Returns
on 25 Portfolios Formed on Size and BE/ME: 12/1991-12/2008, 205
Months ............................................................................................... 84
Table IX The CAPM Time-Series Regressions for Monthly Excess Returns
on the LSV Equal-Weight Quintiles: 12/1991-12/2008, 205 Months
............................................................................................................ 85
Table X The CAPM Time-Series Regressions for Monthly Excess Returns
on Equal-Weight Portfolios Formed on Past Returns: 12/1992-
1/2008, 182 Months ........................................................................... 86
Table XI The Fama French Three-Factor Regressions for Monthly Excess
Returns on 25 Portfolios Formed on Size and BE/ME: 12/1991-
12/2008, 205 Months ......................................................................... 86
Table XII The Fama French Three-Factor Regressions for Monthly Excess
Returns on the LSV Equal-Weight Quintiles: 12/1991-12/2008, 205
Months ............................................................................................... 87

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Table XIII The Fama French Three-Factor Regressions for Monthly Excess
Returns on Equal-Weight Portfolios Formed on Past Returns:
12/1991-1/2008, 182 Months ............................................................. 88
Table XIV Returns for Quintiles Portfolios Based on One-Dimensional
Classification by Various Measures of Value Characteristics Post
Crisis Period ...................................................................................... 89
Table XV Jegadeesh and Titman (1993) Methodology of an Overlapping
Momentum/Contrarian Average Monthly Returns of JKSE Stocks:
12/1991-12/2008 ................................................................................. 90
Table XVI Jegadeesh and Titman (1993) Methodology of an Overlapping
Momentum/Contrarian Average Monthly Returns of JKSE Stocks
Sub-Period Analysis: 12/1991-06/1997 and 08/1998-12/2008 ........ 91
Table XVII Jegadeesh and Titman (1993) Methodology of an Overlapping
Momentum/Contrarian Average Monthly Returns of JKSE Stocks:
12/1991-12/2008 exclude Crisis Period 07/1997-07/1998 ............... 92


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Abstract
This paper examines the presence of the value premium, the size effect, and
momentum versus contrarian strategies in Indonesian stock market for the period
1991-2008. The momentum/contrarian strategies are analyzed using two models, the
Lo and MacKinlay (1990) methodology and the Jegadeesh and Titman (1993)
methodology. This study also analyzes the effect of trading volume in
momentum/contrarian strategies and compares the performance of the CAPM and the
Fama French three-factor model in explaining returns variation of particular
portfolios. The GRS test statistic is performed to investigate whether the intercepts are
jointly zero. The study proves that value and small stocks outperform glamour and big
stocks in Indonesian stock market. In short-term, winners outperform losers due to
investors overestimation towards winners that belong to high lagged volume group.
In medium-term however, investors overreaction to losers is higher than their
overreaction towards winners. Zero-cost strategies in general are in favor of the
contrarian pattern, and are especially pronounced for stocks in lower trading volume.
The Fama French three-factor model only explains slightly better than the CAPM
with the small value portfolios still left unexplained.


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I. Introduction
Market are said to be efficient when stock prices move randomly and show no
discernible pattern. Market anomalies exists when stock prices do move in some
predetermined pattern and investors can earn excess returns by trading around the
pattern. Many studies in U.S. markets and in international markets show the presence
of the three well known market anomalies. They are the value premium, the size
effect and momentum versus contrarian. Researches on the performance of value and
growth stocks and momentum versus contrarian have been previously pursued by lot
of academics and researchers. Value stocks are defined as stocks that have low prices
relative to earnings, dividends, historical prices, book assets, or other measures of
value. Growth (Glamour) stocks, on the other hand are those that have high prices
relative to earnings, dividends, historical prices, book assets, or other measures of
value. For many years, scholars and professionals have argued that value stocks earn
higher returns than growth stocks, the so-called value premium. There is also
evidence that value stocks tend to be smaller in size than growth stocks. Size is
measured by market capitalization which is stocks price times the number of shares
outstanding. The form of market anomalies where small capitalization stocks earn
higher mean returns than large capitalization stocks is called the size effect.
Momentum refers to the idea that stocks that perform well in the past will continue to
do well in the future. Whereas contrarian refers to the idea that bad-performing stocks
in the past will outperform good-performing stocks in the future.

However, the evidence of these market anomalies is not clear; for instance growth
stocks have had higher returns than value stocks in some countries. Because the
behavior of stock markets may differ across geographic regions, it is possible that the
performance of the three market anomalies also vary across countries. The purpose of
this study is to explore the presence of the value premium, the size effect, and
momentum versus contrarian in Indonesia, using the following variables: Book-to-
Market equity (BE/ME), Earning per Price (E/P), Cash Flow per Price (CF/P), market
value of equity (ME, stock prices times number of shares outstanding), trading
volume, and past returns. Further details and explanations for each variables are given

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in Table I. Developing a theoretical analysis of this relationship is beyond the scope of
this paper.

Why Indonesian Stock Market?

The attractiveness of Asian stock markets came under consideration after some
researchers found evidence that by diversifying their portfolio with Asian stocks,
international investors can reduce their risk. Bailey and Stulz (1990) suggest that U.S.
investors can reduce their risks by 30% to 50% by including Asian stocks in their
portfolios since U.S. and Asian markets should perform very differently in any given
periods. The gain from international diversification, however, depends on the degree
of capital markets correlation. Roll (1995) provides additional evidence for the
correlation between Indonesian and other developed countries stock markets. He
found that prior to December 1988, 20 out of 23 measured correlation coefficients
(using monthly returns) were negative, and in contrast during the period from 1989-
1992, most of the correlations were positive. Positive correlation among stock markets
means investors cannot use diversification to reduce unsystematic risks. However,
Rolls findings which end on 1992 seem to suggest that markets correlation might be
different across periods. Since this study incorporates different sample period (from
1991 to 2008) which ends after that of Rolls, the correlation pattern between
Indonesian and other developed countries stock markets might be changing as well.
Furthermore, as documented by Malliaropolus and Priestley (1999), investing in
emerging markets, especially in Asia is interesting due to the high volatility
characteristics of these markets. They observe that emerging markets have high
volatilities and thus high expected returns. Increasing attention from investors and the
relatively unknown nature of emerging markets place research in these areas at high
priority.

Although many researchers have focused on the performance of Asian market,
especially Japanese stock market, Indonesian stock market seems to be virtually
uncovered and in that sense provides the opportunity to examine and to contribute for

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evidence of market anomalies in the form of the value premium, the size effect and
momentum versus contrarian. The importance of Indonesian stock market for
international investors has increased from 2002-2008. Table II shows the total trading
value for locals and foreigners from 2002 to the first quarter of 2008. The percentage
of foreign transaction from total trading value has increased from 11.27 percent in
2002 to 24.72 percent on the first quarter of 2008.

The performance of value and growth stocks in Indonesia has been examined by few
researchers with mixed and inconsistent results. Ding et al. (2005) examine value and
growth portfolios in seven East Asian countries just prior to the Asian Financial
Crisis. They conclude that Indonesian stock market do not reveal any particular firm
size or growth potential effects. On the other hand, Roll (1995) provides the evidence
that value portfolio of Indonesian equities performed much better than the growth
portfolio during 1989-1992 periods. These mixed results may be due to a number of
reasons, including: (i) the differences in data sources or study periods; (ii) the
differences in the formation (ranking) periods and in the investment holding periods
1
;
(iii) different methodologies
2
; and (iv) the differences in the sample stocks (e.g.,
aggregate market indices or individual stocks), etc.

The choice of predictor variables as explained in Table I, is motivated by the existing
evidence, especially in the U.S. which, in turn, is influenced by the practice of
fundamental security analysts. Wherever possible, this study attempts to draw
parallels between this research and those from previous studies. On the one hand,
findings that the same factors are at work in both studies would strengthen the
evidences accumulated for these kinds of stock market anomalies. On the other hand,
different findings would suggest further research exploring institutional or behavioral
differences between Indonesian stock market and other international markets.

1
Formation (ranking) period refers to the period in which stocks are ranked based on particular value
characteristics in order to form the portfolios. Investment holding period refers to the period in which
stocks are hold before finally being sold by investors to realize profit.
2
Different methodologies can generate different results. This study uses both Lo and MacKinlay
(1990) methodology and Jegadeesh and Titman (1993) methodology in analysing the performance of
momentum versus contrarian strategies. However, in this study, both methodologies provide same
conclusions. Further details regarding both methodologies are provided in section III.

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This study is different from past studies in two significant ways. Firstly, the majority
of the past studies on Asian markets rely on data that end prior to the year 2000 or
even prior to the Asian financial crisis of 1997-1998. Therefore, the robustness of
their reported findings is questionable for the post-2000 study. This research utilizes
most recent data and study period that ends in December 2008. More specifically, this
research will examine the performance of the value premium, the size effect and
momentum versus contrarian from December 1991 to December 2008 period.
Secondly, this research also attempts to shed light on the relation between return
predictability and trading volume.

The decision to incorporate trading volume in explaining momentum and contrarian is
based on four considerations. Firstly, the evidence on return predictability in emerging
markets may suffer from data problems such as non-synchronous trading or thin
trading.
3
Non-synchronous trading problem arises when the prices of distinct
securities are mistakenly assumed to be sampled simultaneously. Different securities
might have different trading performances. Specifically, many securities are traded
only infrequently, with few securities so actively traded that prices are recorded
almost continuously. Because prices for most securities are reported only at distinct
random intervals (for instance monthly or annually), completely accurate calculation
of returns over any fixed sequence of periods is virtually impossible. Treating
nonsynchronous prices as if they were observed at the same time can create
econometric problems. Lo and MacKinlay (1990) show that non-synchronous trading
effects add to contrarian profits. Therefore, incorporating trading volume is expected
to reduce the problems by capturing the extent to which momentum and contrarian
profits are due to lack of trading. In other words, by dividing stocks into volume
groups enable comparison among stocks with the same trading performance.
Secondly, volume has been believed to provide information about future price
movements. There is a common belief that it takes volume to move prices. Without
sufficient trading volume, stock prices may react less to information on low trading
activity; therefore the momentum strategies applied to these stocks will be profitable.

3
In this study, following Lo and MacKinlay (1990), the terms thin trading and non-synchronous
trading are used interchangeably.

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Thirdly, only few observations have been made combining the role of volume in price
predictability in Indonesian stock market and this study attempts to fill the gap. Last
but not least, as a practical concern, investors should take liquidity into account when
trading in emerging markets.

The primary findings of this study are: (i) The value premium exists in Indonesian
stock market during the sample period; (ii) The two-independent sort strategies, the
strategies that sort stocks independently based on two value characteristics, especially
those which incorporate value-weighted return, produce higher average annual return
than those strategies that are based exclusively on individual-sort; (iii) The Fama-
French three-factor model is slightly better when it comes to explaining variation in
stock returns than the simple CAPM
4
; (iv) In the medium term, investors
overreaction to losers is higher than their overreaction towards winners; in short-term,
winners outperform losers due to investors overestimation towards winners that
belong to high lagged volume group; (v) zero-cost strategies in general are in favor of
the contrarian pattern, and are especially pronounced for stocks in lower trading
volume.

The remainder of this study is structured as follows. Chapter two provides an
overview of the literature on which this research is based as well as a short overview
of traditional CAPM model. Chapter three describes the dataset as well as the
methodology in use. Chapter four presents the empirical results and contains an
analysis on the performance of value premium, size effect, and momentum/contrarian
strategy. Chapter five continues with the robustness check and the results of time-
series regressions using both the simple CAPM and the Fama French three-factor
model. Finally, chapter six provides conclusions and limitations to the study.

4
It should be noted that this study does not take into account the time-varying beta, the structural
break, or any advance CAPM tests. Further investigation regarding these matters may provide better
analysis in the results of the regression test.

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II. Literature Review
This literature review attempts to depict an overview over a selection of seminal and
influential studies in the area related to the three well known market anomalies; value
premium, size effect, and momentum versus contrarian. Since the so-called anomalies
can be regarded as a failure in traditional asset pricing model, this review begins with
documenting the traditional Sharpe-Lintner CAPM. The following subsections will
then cover an overview of each anomaly tested in Indonesian stock market.

1. The Traditional CAPM
The capital asset pricing model (CAPM) of William Sharpe (1964) and John Lintner
(1965) marks the birth of asset pricing theory. While CAPM seems to offer superior
predictions about how to measure risk and the relation between expected return and
risk, the empirical record of the model is poor.

The originality of CAPM was based on Harry Markowitzs Modern Portfolio Theory.
Markowitzs model assumes that investors are risk-averse and their considerations
when choosing among portfolios are the mean and variance of the one-period
investment return. As a result, investors choose mean-variance-efficient portfolios,
which are the portfolios that either 1) minimize the variance of portfolio return, given
expected return, or 2) maximize expected return, given variance. Therefore, in the
investment universe of possible portfolios, investors choose the ones with optimal
balance of risk and reward. All the optimal portfolios will construct an efficient
frontier of portfolios.

Sharpe (1964) and Lintner (1965) expand Markowitzs model by adding two
assumptions. First, the complete agreement assumption: given market clearing asset
prices at t-1, investors agree on the joint distribution of asset returns from t-1 to t.
Second, the borrowing and lending at a risk-free rate, which is the same for all
investors and does not depend on the amount borrowed or lent.
Figure 1 shows the risk-return tradeoff in investment opportunities. The horizontal
axis shows portfolio risk, measured by the standard deviation of portfolio return. The

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vertical axis shows the expected return. The curve abc provides the combinations of
the minimum-variance-efficient portfolios. On Figure 1, the tradeoff between risk and
expected return for minimum-variance-efficient portfolios are clearly described. For
example, an investor who wants the highest expected return in efficient frontiers line,
point a, must accept higher volatility than investor in point b. If there is no risk-free
borrowing or lending, only portfolios above b along abc are mean-variance-efficient,
since these portfolios also maximize expected return, given their return variances.

The inclusion of Sharpe (1964) and Lintner`s (1965) assumption of risk-free rate on
abcs curve turns the efficient set into a straight line. In short, the line can be
explained by the following example: An investor investing the proportion x of
portfolio funds in a risk-free security (
]
) and 1 in some portfolio g. If all funds
are invested in the risk-free security, investors can expect return on the point R
f
. By
diversifying the investment in part on risk-free security and in part on risky assets g,
the result is the straight line between
]
and g.
Formally, the return, expected return and standard deviation of return on portfolios of
the risk-free asset f and a risky portfolio g vary with x, the proportion of portfolio
funds invested in f, as:

p
=
]
+ (1 )
g
(1)
(
p
) =
]
+ (1 )(
g
) (2)
o(
p
) = (1 )o(
g
), 1.u, (3)

Mean-variance-efficient portfolio with risk-free borrowing and lending can be
obtained by drawing a tangent line from
]
to the abc curve in Figure 1 with an
intersection on portfolio T, the so-called Capital Market Line. Thus, all efficient
portfolios are combinations of a risk-free asset (either risk-free borrowing or lending)
and a single risky tangency portfolio, T. Overall, all investors have the same
opportunity set and they combine the same risky tangency portfolio T with risk-free
lending or borrowing. Since all investors hold the same portfolio T of risky assets, it
must be the value-weight market portfolio of risky assets. Specifically, each risky

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assets weight in the tangency portfolio, which we now call M, Market, must be the
total market value of all outstanding units of the asset divided by the total market
value of all risky assets. In addition, the risk-free rate must be set (along with the
prices of risky assets) to clear the market for risk-free borrowing and lending.

The main implication of CAPM is that in market equilibrium, the value-weighted
market portfolio, M, must be on the mean-variance-efficient frontier. The mean-
variance-efficiency of M in turn says that (i) , the slope in the regression of a
securitys return on the market return, is the only risk needed to explain expected
return; (ii) there is positive expected premium for risk.

As emphasized by Fama and French (2004), a risky assets return is uncorrelated with
the market return; its beta is zero, when the average of the assets covariances with the
returns on other assets just offsets the variance of the assets return. Such a risky asset
is riskless in the market portfolio in the sense that it contributes nothing to the
variance of the market return. Sharpe (1964) and Lintner (1965) argue that when there
is risk-free borrowing and lending, the expected return on assets that are uncorrelated
with the market return must equal the risk-free rate ,
]
. Thus, Sharpe-Lintner CAPM
equation becomes:
(
) =
]
+ |(
M
)
]
][
M
, = 1, , . (4)
In words, the expected return on any asset i is the risk-free interest rate,
]
plus the
risk premium, which is the assets market beta, [
M
, times the premium per unit of
beta risk, (
M
)
].
Rearranging equation (4), the Sharpe-Lintner CAPM become,
(
)
]
= |(
M
)
]
][
M
(5)
Thus, Sharpe-Lintner CAPM predicts that an asset expected excess return can be
explained by the risk premium. Alternatively, according to CAPM, the market
compensates investors only for taking systematic risk, which is measured by beta, but
not for taking specific risk.


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According to Fama and French (2004) there are three standard tests of the CAPM.
The purpose of the tests is to examine whether loadings on a market proxy can
describe the average returns on other portfolios. Tests of the CAPM are based on three
implications of the relation between expected return and market beta implied by the
model. Firstly, expected returns on all assets are only linearly related to their betas,
and no other variable has marginal explanatory power. Secondly, the beta premium is
positive, which means that the expected return on the market portfolio exceeds the
expected return on assets whose returns are uncorrelated with the market return.
Third, in the Sharpe-Lintner CAPM, assets uncorrelated with the market have
expected returns equal to the risk-free interest rate, and the beta premium is the
expected market return minus the risk-free rate.

Empirical evidence, however, shows that CAPM fails to explain the first and second
implication. In practice, beta premium is not always positive. According to Leland
(1999), the fact that beta is negative means that the CAPM model is misspecified
since estimates of alpha will be incorrect. This inverse relationship between beta and
returns seems to contradict the basic theory in empirical finance. The basic SLB
CAPM model generally assumes that the expected return for any securities is a
positive function of only three variables, which are beta, the risk-free rate, and the
expected market return. There are three contradictions of the use of beta as a proxy of
systematic risk for a security. Firstly, Chen, Roll, and Ross (1986) argue that in order
to measure the systematic risks, not only beta, but also macroeconomic variables have
to be taken into account. Secondly, Lakonishok and Shapiro (1986) observe that
security returns are also affected by various measures of unsystematic risk. Finally,
Fama and French (1992) investigate the absence of a systematic relationship between
beta and security returns.

In order to explain the existence of negative risk premium, I follow the arguments
from Pettengill, Sundaram, and Mathur (1995). They argue that the positive
relationship between returns and beta predicted by the Sharpe-Lintner-Black (SLB)
CAPM model is based on expected rather than realized returns. The assumption of a
positive risk-return tradeoff requires that the expected return to the market must be

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greater than the risk-free rate ((
m
)
]
) > u); otherwise all investors would hold
the risk-free security. This assumption implicitly asserts that the expected return to
any risky portfolio is a positive function of beta. In the real world, however, investors
must consider a nonzero probability that the realized market return will be less than
the risk-free return. Consequently, the relationship between beta and realized returns
can differ from the relationship between beta and expected return required by the
general CAPM model. However, the model does not provide any arguments regarding
the relationship between portfolio beta and portfolio returns when the realized market
return is less than the risk-free return. Pettengill, Sundaram, and Mathur (1995) argue
that if the realized market return is less than the risk-free rate, an inverse relationship
exists between beta and predicted return (i.e., high beta portfolios have lower returns
than those of low beta portfolios). Fletcher (1997) also observes that in periods when
the excess return is positive (up market), there is a positive relationship between beta
and returns and in periods when the excess market return is negative (down market),
there should be a negative relationship between beta and returns.

Furthermore, researchers have identified many patterns in average stock returns, for
example the so called-value premium, size effect, momentum, and contrarian. All
those patterns cannot be explained by the Sharpe-Lintner CAPM and thus, they are
typically called market anomalies.

2. The Value Premium
The topic of value and growth investing has already been a popular concept for
academic research and investment practice. Investment strategies that focus on value
stocks investing are claimed to outperform the market.

2.1 Evidence in U.S. Market
Basu (1977) and Jaffe et al. (1989) find that stocks with low P/E values can generate
positive abnormal returns. Basu (1977) reports that P/E information was not fully
reflected in security prices, consequently, securities trading at different multiples of
earnings, on average, seem to have been inappropriately priced vis--vis one another.

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This evidence violates the semi-strong form of the efficient market hypothesis. Fama
and French (1992 and 1996) report that value strategies (buying stocks that have low
prices relative to earnings, dividends, historical prices, cash flow, book value, other
measures of intrinsic value) yield higher returns than growth strategies. Davis (1994)
finds that BE/ME, E/P, and CF/P have significant explanatory power with respect to
the cross-section of realized stock returns.

2.2 Evidence in International Markets
The evidence in international markets largely supports the existence of value
premium. Capaul et al. (1993) conclude that the returns on value stock portfolios (low
P/B) outperform those from growth stocks portfolios (high P/B) in the six countries
they observed (France, Germany, Switzerland, the U.K., Japan and The U.S. Haugen
and Baker (1996), which confirm that value premium in international markets exists
even after controlling for risk, liquidity, growth potential and past price history. Fama
and French (1998) examine out-of-sample test in sixteen emerging markets and found
that sorting on BE/ME, E/P, CF/P, and D/P, value stocks outperform growth stocks.
Bauman, Conover, Miller (1998) extend Capaul et al. (1993) to encompass all of the
20 established markets represented in the MSCI Europe/ Australasia/ Far East (EAFE)
Index, as well as Canada, and to examine value and growth stocks on the basis of P/E,
P/CF, and dividend yield (D/P). They find that value portfolios outperform growth
portfolios in most countries by a large margin. However, investors should carry out
additional financial research when making final international investment selections
since value stocks as a group do not provide the best performance every year and in
every market.

2.3 Evidence in Asian Markets
Many studies support the existence of the value premium in Asian markets. However,
the empirical evidence is inconclusive. Chan, Hamao, and Lakonishok (1991) observe
Japanese stock market and find positive significant relationship between BE/ME and
CF/P and expected returns. However, they are not able to determine unambiguously
whether the returns predictability is due to market inefficiency or deficiencies in the

19

asset-pricing model. Yen, Sun, and Yan (2004) find value premium for Singapore
stocks, with the premium being concentrated in the first 2 years after the portfolio
formation. Ding et al. (2005) examine value and growth portfolios in seven East Asian
countries before the Asian Financial Crisis and find insignificant or zero value
premium in Indonesia and Taiwan; a negative premium in Thailand, but significant
positive value premium in Hong Kong, Japan, Malaysia and Singapore. In contrast,
Bauman et al. (1998) report insignificant value premium for Hong Kong and
Singapore. Brown, Rhee, and Zhang (2008) investigate value premium in four Asian
markets: Hong Kong, Korea, Singapore, and Taiwan. They find that value premium
becomes greater in the post-crisis period across all four countries, indicating that high
volatility during the crisis period did understate the value premium. More advanced
research in value premium in Japan is being conducted by Bauer, Derwall, and
Molenaar (2004). They examine whether the short-term variation in the Japanese size
and value premium is sufficiently predictable to be exploited by a timing strategy.
Their results confirm the evidence of sufficient predictability. However, the benefits
are more pronounced under lower transaction costs.

Nevertheless, the underlying reasons that value stocks (those with high BE/ME, low
P/E, low P/B, low P/D ratios) earn superior return than growth (glamour) stocks
remain a puzzle in asset pricing. Some researchers argue that the observed
predictability is an artifact of the research design and database used to conduct the
study. Kothari, Shanken, and Sloan (1995) argue that the predictability of certain
variables would be reduced or vanish if different methodology and data were used.
Davis (1994) addresses this problem by using a dataset that eliminates some of these
concerns and still find significant relationships between certain fundamental variables
(BE/ME, CF/P, and E/P) and subsequent returns during his study period.

The second explanation on why value strategies have produced superior returns
compared to its relative, growth or glamour strategies is that they are fundamentally
riskier. This rational interpretation is being supported by Fama and French (1992).
They argued that value premium is the compensation for bearing risk. Fama and
French (1996) argued that stocks with high BE/ME are more prone to financial

20

distress and are hence riskier than growth stocks. Chan and Lakonishok (2004),
however, argue that the risk argument stretches credulity. On the basis of the risk
argument, Internet stocks, which had virtually no book value but stellar market value
in the 1990s, would be considered much less risky than traditional utility stocks,
which typically have higher BE/ME. In addition, there is also data snooping evidence
since the idea that value stocks have higher risk appeared only after their higher
returns became apparent. Lakonishok, Shleifer, and Vishny (1994) use stock market
performance as a proxy of risk. If the value strategy is fundamentally riskier, it should
underperform growth strategy during undesirable states of the world when the
marginal utility of wealth is high. They report that there is no evidence that superior
value stocks performance reflect their higher fundamental risk.

In accordance to the behavioral model, Kahneman and Tversky (1982) explain that
compared to value stocks, growth stocks are characterized as having higher recent
growth rates in earnings per share and market appreciation. They suggest that
forecasters tend to put more emphasis on more recent information relative to older
data. So far as investors and analysts overlook the lack of persistence in growth rates
(Chan, Karceski, and Lakonishok 2003) and project past growth into the future,
favorable sentiment is created for growth (glamour) stocks and drive overvaluation of
growth stocks. In favor of overreaction hypothesis, Bauman et al. (1998, 1999) argue
that value premium in international stock markets is due to investors and research
analysts overreacting to past corporate earnings trends of growth stocks and value
stocks. Value premium occurs because investors fail to recognize that corporate
growth trends have a mean-reversion tendency or behave as a random walk.
Consequently, when earnings disappointments are reported, growth stocks tend to
have lower returns than value stocks.

Lakonishok et al. (1994) claimed, however, that value strategies might produce higher
returns because they are contrarian to naive strategies followed by other investors.
These nave strategies tend to overestimate future earnings of growth stocks relative
to value stocks. The investors are overly optimistic about stocks that have done very
well in the past, so investors bid their prices up and make the price of growth stocks

21

became overvalued. On the other hand, value stocks, which have past bad earnings,
are undervalued. Nave investors make systematic errors in predicting future growth
in earnings of value stocks, and this error in expectation and overly reaction to bad
and good stocks are the cause of value premium. This non-risk-based explanation is
known as the extrapolation or errors-in-expectations explanation.

Chan and Lakonishok (2004) suggest that value premium may be evidence of agency
factors. Analysts have self-interest in recommending successful stocks to generate
trading commissions. Moreover, growth stocks are typically in exciting industries and
are subject to analyst reports and media coverage. Furthermore, analysts
performances are being evaluated on a short-term basis and are subject to investors
scrutiny. Since value stocks reward investor in the longer-term, their short-term
performance is not so astonishing and investors will put pressure for analysts
holdings of these stocks. The upshot of all these considerations is that value stocks
become underpriced and growth stocks overvalued relative to their fundamentals.
Shleifer and Vishny (1997) provide the argument of why these mispricing patterns
can persist over long periods of time. They argue that such market anomalies may
diminish when investors become knowledgeable about the strategy being used. The
anomalies are more easily accepted when the returns pattern is not very noisy (not so
volatile) and the payoff horizon is short. However, value-growth anomaly is accepted
only slowly, even by relatively sophisticated investors.

Other argument about the superiority of value stocks is proposed by Doukas, Kim,
and Pantzalis (2004), who argue that higher returns for value stocks are exposed to
greater disagreement among investors, which influences stocks prices. They suggest
that in imperfect capital markets, capital market equilibrium requires the simultaneous
determination of asset prices and of the identity of investors (that is, investors
opinions) trading in each asset. This dispersion of opinion, then, potentially represents
a unique source of risk, and its impact on prices should be compounded by the degree
of disagreement. To examine the investors disagreement about future payoffs, they
used the dispersion in analysts earnings forecasts as a proxy for investors
heterogeneous beliefs. Value stocks are those which have greater exposure to

22

dispersion in analysts forecasts and thus should earn a higher return. Similarly,
glamour stocks are those that have lower exposure to dispersion in analysts forecasts
and thus earn a lower return. They found that value strategies outperform growth
strategies and the return advantage of value strategies reflects, at least in part,
compensation for bearing risk associated with higher dispersion in analysts earnings
forecasts, which confirms the conjecture of Williams (1997) that dispersion of opinion
represents risk. Hence, the superior return of value stocks should be viewed as a
reward for the greater investor disagreement about the stocks future growth in
earnings.

3. The Size Effect
The other form of market anomaly is the size effect, in which small capitalization
stocks have higher mean returns than large capitalization stocks. Some researchers
argue that small capitalization stocks are actually inherently riskier than large
capitalization stocks because there is less information about them, and standard
measurement of risk do not capture this discrepancy in the amount of available
information. Small capitalization stocks outperformance can be observed in the form
of neglected-firm-effect, in which firms with low analyst coverage tend to have
higher-risk-adjusted returns (Chincarini and Kim (2006)).

The researches on size effect are first reported by Banz (1981), who argued that
smaller firms have had, on average, higher risk adjusted returns than larger firms. He
conjectures that one possible explanation for the size effect is that some firms have
insufficient available information which hinders investors to hold their stocks. Thus,
lack of information about small firms leads to limited diversification and therefore
higher returns for the undesirable stocks of small firms.


23

Jaffe et al. (1989) examine the impact of firm size on P/E. Jaffe et al. find the size
effect to be significantly negative only in January, the so-called January Effect.
5
Fama
and French (1992) also demonstrate that in the U.S. market, firm size provides a good
explanation of cross-sectional stock returns. Fama and French (1993, 1995) reported a
continuous finding about the negative firm size effect which arises because firm size
and the book-to-market ratios are proxies for non-diversifiable factor risk.

The other interpretation of the size effect is provided by Chan and Chen (1991) who
argue that smallness by itself does not necessarily mean higher risk, and differences in
market capitalizations do not explain why small and large firms respond differently to
economic news. They argue that small firms are riskier because they tend to be what
we call marginal firms. They have lost market value because of poor performance,
they are inefficient producers and they are likely to have high financial leverage and
cash flow problems. Marginal firms tend to have higher price sensitivity to economic
changes and they are less likely to survive adverse economic conditions.
Consequently, small-marginal firms will react differently than large-healthy firms to
the same piece of macroeconomic news. As a result of the difference in production
efficiency and difference in leverage, small firms tend to be riskier than large firms,
and the risks of the smaller firms are not likely to be captured by a market index
heavily weighted toward large firms.

4. Momentum versus Contrarian Strategies
Many researchers have confirmed that past stock performances have the ability to
predict future performance. Researchers define two strategies based on stocks past
performance; the so-called momentum strategy which is based on price continuation
and the contrarian strategy that follows the reversal pattern. Momentum strategy

5
January effect is one of market anomalies in which small capitalization stocks and last years poorly
performing stocks tend to outperform in January. According to Lee (1991), January effect may occur
from investors behavior in the end of the year that sell stocks that have declined in price during the
year to reduce their taxes, thereby putting downward pressure on stock prices. However, as soon as the
year ends, investors start to repurchase the stocks which already undervalued in prices. Consequently,
the selling pressure ends and hence stock prices rebound to their equilibrium levels, resulting in
abnormally high returns in early January.

24

refers to buying stocks that did well in the past and contrarian strategy refers to
buying stocks that have performed badly in the past.

In analysing the performance of momentum versus contrarian, this study uses two
methodologies, Lo and MacKinlay (1990) methodology and Jegadeesh and Titman
(1993) methodology. Lo and MacKinlay define winners as stocks that outperform
the market during the formation period and define losers as those that underperform
the market during the formation period. Jegadeesh and Titman methodology ranks
stocks in ascending order based on their past performance. Winners refer to stocks
that fall into portfolio with the highest 30 percent rank whereas losers refer to
stocks that belong to portfolio with the lowest 30 percent rank. In other words,
momentum strategy refers to buying winners and selling losers, whereas contrarian
strategy refers to buying losers and selling winners.

4.1 Momentum and Contrarian Evidences in U.S. Stock Market
The literature of stock market anomalies in the form of contrarian and momentum
strategies is largely attributable to the seminal work of DeBondt and Thaler (1985).
They investigate return patterns over an extended period of time and find that
contrarian strategies contribute abnormal returns over three to five year horizons.
Initially, the contrarian profits were represented as a long-run phenomenon. More
recent findings by Jegadeesh (1990) and Lehmann (1990), however, provide evidence
of short-term return reversals. Jegadeesh (1990) documents contrarian profits of about
2 percent per month from a strategy that buys and sells stocks based on their prior
monthly returns and holds them for one month. Lehmann (1990) provides similar
findings using weekly portfolio formation.

On the other hands, Jegadeesh and Titman (1993, 2001) find that momentum
strategies generate positive returns about 1 percent per month over three to 12 months
holding period. However, they found that the excess returns of these past winners and
losers in the year following the portfolio formation date dissipate within the following
two years. More broad investigation in the U.S. market by Conrad and Kaul (1998)

25

find that both momentum and contrarian strategies contribute to significant profits
depending on the time horizon investigated. In conclusion, the contrarian strategy is
profitable for short-term (weekly, monthly) and long-term (two to five years, or
longer) horizons, while momentum strategy is profitable for intermediate-term (three
to 12 months) intervals.

Similar studies have also been conducted on the international stock markets with
various conclusions. Rouwenhorst (1998) finds profitable intermediate-term
momentum strategies in twelve European markets between 1980 and 1995. He also
observes that U.S. and European markets have common factors that drive the
profitability of momentum strategies.

In contrast with U.S. and European markets, the evidence of momentum and
contrarian profits is much weaker in Asian markets. Chui, Wei, and Titman (2000)
investigate some Asian markets and find momentum profits except for Japan and
Korea. Griffin, Xiuqing, and Martin (2003) find that Asian stock markets display the
weakest momentum returns among 39 international markets.

4.2 Asymmetric Reactions to good news as opposed to bad news
Based on the argument that winners and losers do not necessarily evoke the same
investor responses, nor do they share similar patterns in price movements, some
researchers evaluate the performance of winners and losers independently. T.H.
McInish et al. (2008) provide more integrated approach to momentum and contrarian
strategies in seven Asian stock markets during the period between 1990 and 2000.
They present evidence of the behavior of each winner stocks and loser stocks. They
found that winners display contrarian behavior while losers show subsequent price
continuation in all seven countries except for Taiwan and Korea. Nam, Pyun, and Kim
(2003) report that winner have longer mean reversion pattern than loser in the nine
Pacific Basin markets they studied.


26

4.3 Trading Volume and Momentum versus Contrarian Strategies
Both academics and practitioners have recently combined the use of trading volume in
examining both momentum and contrarian strategies. The use of trading volume in
predicting future stock returns is more relevant in emerging stock markets where thin
trading is more pervasive. The inclusion of trading volume is strongly subject to non-
synchronous trading problems as noted by Lo and MacKinlay (1990). Chordia and
Swaminathan (2000) investigates that trading volume is a significant determinant of
the cross-autocorrelation patterns in stock returns. Blume et al. (1994) present a model
where investors can use volume information in addition to historical price information
in projecting future price changes, suggesting an information signaling role of volume
in return predictability. Fung, Leung, and Patterson (1999) who incorporate trading
rule in their strategies find that as opposed to T.H. McInish et al. (2008), daily
winner exhibits momentum pattern whereas loser have reversal pattern during the
ensuing one to five trading days.
6
Hameed and Ting (2000) examine the relation
between short-horizon (weekly) return predictability and the level of trading activity
(trading volume) in the Malaysian stock market. They find that contrarian profits on
actively traded stocks are significantly higher than those on low trading activity
stocks. Lee and Swaminathan (2000) present the evidence that high volume stocks are
more favorable than low volume stocks for both investors and analysts. Conrad,
Hameed, and Niden (1994) find that high volume securities experience price
reversals, while low volume securities experience price continuations.

4.4 Sources of Momentum and Contrarian Profits
The profitability of both momentum and contrarian strategies have been well provided
and accepted by many researchers and practitioners. However, the sources of profits
as well as the interpretation of the evidence are widely debated. Some argue that
momentum and contrarian profits are the evidence of market inefficiency; while

6
It should be noted that the momentum behavior (reversal) for winner (loser) stocks as observed by
Fung, Leung, and Patterson (1999) are being criticized as a result of research design. Their study
period, 1980 until 1993, is a bullish market period. Therefore the higher proportion of daily return of
stocks observed should be positive.

27

others argue that the returns from these strategies are either compensation for risk, or
alternatively, the product of data mining.

Alternative explanations of factors that drive momentum or contrarian strategies:
1. Data mining
The criticism that observed market anomalies are due to data mining is typically
the hardest to address because of the limitation of available data. Fortunately,
with the passing of time, there are additional periods of data that enable
researchers to perform out-of-sample tests as well as to assess the extent to which
investors may have learned from the earlier return pattern.

Jegadeesh and Titman (2001) perform the same research using longer observation
time and found the same result that momentum strategies continue to be
profitable and that past winners outperform past losers by about the same
magnitude as in the earlier period. These kinds of anomalies are argued to be the
result of investors under-reaction which in intermediate term, past winners still
outperform past losers.

2. Behavioral Model
Under-reaction
Chan, Jegadeesh, and Lakonishok (1999) observe that momentum strategies may
be profitable because they exploit market under-reaction to different pieces of
information. Their results indicate that market is slow to incorporate in its
valuations the full impact of information. For instance, market may under-react
both to information about the short-term prospects of companies that will
ultimately be manifested in near-term earnings and to value-related information
about the long-term prospects of companies that have not yet fully captured by
near-term earnings forecasts or past earnings growth. In addition, they also
provide evidence that analysts are especially slow in revising their forecast.

The behavioral models advocates, Barberis, Shleifer, and Vishny (1998); Daniel,
Hirshleifer, and Subrahmanyam (1998); and Hong and Stein (1999) argue that

28

momentum and contrarian profits may arise because of inherent biases in the way
that investors interpret information. The behavioral models imply that the holding
period abnormal returns arise because of a delayed overreaction to information
that pushes the prices of winners above their long-term values and presses the
prices of losers below their long-term values. On the other hand, for intermediate-
term momentum profits, Jegadeesh and Titman (1993, 2001) and Chan,
Jegadeesh, and Lakonishok (1996) argue that the prime source of momentum
profits is investors under-reaction to market news.

Previous behavioral literature, for example, Barberis et al. (1998) argue that it is
conservatism bias which might lead investors to under-react on ranking period
information, which, in turn, leads to momentum profit on medium-term. The
conservatism bias suggests that investors underweigh new information in
updating their priors and prices will tend to slowly adjust to information.
However, once the information is fully incorporated in prices, there is no further
predictability in stock returns and post-holding period will be zero.

Recent behavioral literature provides evidence that the post-holding period
returns may in fact be negative. Behavioral models predict that in subsequent
time periods, when the stock prices of the winners and losers revert to their
fundamental values, the returns of losers should exceed the returns of winners.
Barberis et al. (1998) try to explain the long-term reversal as well as the short-
term momentum by combining conservatism bias and representative heuristic
by Kahneman, Slovic, and Tversky (1982).
7
They argue that the representative
heuristic leads investors to mistakenly extrapolate past performance earning
growth too far in the future. They explain that although the conservatism bias in
isolation leads to under-reaction, this behavioral tendency in conjunction with the
representative heuristic can lead to long horizon negative returns for stocks with
consistently high returns in the past.

7
Representative heuristic is the tendency of individuals to identify an uncertain event, or a sample, by
the degree to which it is similar to the parent population.

29

Herding Behavior
Herding behavior suggests that investors tend to flock together. This behavioral
model is more pronounced in the mutual funds. Grinblatt, Titman, and Wermers
(1995) observe that majority of mutual funds purchase past winner stocks and
tend to invest more intensely with the crowd. Lakonishok et al. (1994) find
evidence that pension fund managers tend to either buy or sell in herds, with
slightly stronger evidence that they flock around small stocks.
Self-Attribution Bias
Daniel, Hirshleifer, and Subrahmanyam (1998) suggest that informed traders
suffer from a self-attribution bias. Informed traders tend to attribute good
performance to their stock selection skills and attribute bad performance to bad
luck. Due to this cognitive bias, investors become overconfident and overestimate
their prediction for good past performance stocks. This overreaction pushes up
the prices of winner above their fundamental value, and leads to short-term
momentum profits that are eventually reversed in the long-term.

3. Cross-sectional variations in stock returns
Conrad and Kaul (1998) report that stocks with high unconditional expected rates
of return in adjacent time periods are expected to have high realized rates of
returns in both periods, and vice versa. Based on that hypothesis, Conrad and
Kaul (1998) argue that momentum strategies will yield positive returns on
average even if the expected returns on stocks are constant over time. They
suggest that the higher returns of winners in the holding period represent their
unconditional expected rates of return and thus predict that the returns of the
momentum portfolio will be positive on average in any post-ranking period.

4. Lead-Lag Structure in Portfolio Returns
Lo and MacKinlay (1990) provide evidence that contrarian profits are due to a
lead-lag structure in portfolio returns. The idea is that some securities adjust
slowly (under-react) to information and this under-reaction contributes to
asymmetric predictability in size-sorted portfolio returns. For example, if the
price changes of stock A lead that of stock B, a contrarian profit may exist from

30

buying stock B subsequent to an increase in stock A and selling stock B
subsequent to a decline in stock A. Chordia and Swaminathan (2000) attribute the
lead-lag patterns to low-volume stocks adjusting more slowly than high-volume
stocks to market wide information shocks.

5. Compensation for Risk
Chan (1988) suggests that an investor who follows the contrarian strategy earns
abnormal returns as a compensation for the risk in the investment strategy and the
investors risk exposure varies inversely with the level of economic activity. The
contrarian strategy appears to have an ability to pick riskier losers when the
expected market risk premium is high, probably because losers suffer larger
losses at economic downturns than at upturns. The other proponents of risk, Ball
and Kothari (1989) provide evidence in U.S. market that loser stocks have
significantly higher betas than winner stocks in the test period. The consensus in
the literature argues that risk factors do not completely explain intermediate
horizon momentum profits. Fama and French (1996) concede that their three-
factor asset-pricing model as an approach for risk factors cannot explain the
medium-term momentum profits. Chordia and Shivakumar (2002) incorporate
macroeconomic variables and find that momentum profits can be explained as
compensation for macroeconomic risk factors. However, Griffin et al. (2003) find
that the relation between macroeconomic risk exposure and momentum profit
does not exist in international markets. Rouwenhorst (1998) examines 12
European markets and find that controlling for market risk or exposure to a size
factor increases the abnormal performance of medium-term momentum
strategies. Richards (1997) presents evidence that loser portfolios have lower
standard deviation than winner portfolios at all horizons.

6. Size Effect and Seasonality
Zarowin (1990) argues that superior performance of losers compared to winners
is not due to investor overreaction, but instead is an evidence of the size and/or
January effect. He provides that by the end of the ranking period, losers tend to be
smaller-sized than winners.

31

III. Data Analysis
This section begins with an overview of the Indonesian Stock market. Afterwards, the
methodology employed in this study is introduced. The final subsections comprise the
detailed explanation of the empirical tests in this research.

1. Indonesia Stock Exchange
Indonesian stock market has existed long before the independence of Indonesia
(August 17, 1945). The first stock exchange in Indonesia was established in Batavia
(currently known as Jakarta) by the Dutch East Indies on December 14, 1912.
However, the first computerized trading system was introduced on 1995. Therefore,
the earliest data of Indonesian stock market used in this study has only been available
since 1991. Figure 2 shows the milestones of Jakarta Composite Index from 1984 to
2008.

As emphasized by Kothari, Shanken, and Sloan (1995), some databases suffer from
survivorship-bias due to the exclusion of delisted or non-surviving firms from the
database. Since only the surviving firms historical data are added to the database, the
true economic significance of the variables will likely be overstated. This study
potentially suffers from the same bias. The potentially serious bias is due to the non-
availability of some delisted stocks in DataStream database. The impact of the
survivorship bias however, is not significant since the number of delisted companies
is not large enough to provide meaningful differences in the results.

2. Data
The universe of stocks is the Indonesia Stock Exchange (JKSE, Jakarta Composite
Index). The sample period covered in this study ranges from the end of December
1991 to the end of December 2008. In this research, some sample selection criteria is
used as follows. Firstly, following Brown, Rhee, and Zhang (2008), the sample is
limited to listed domestic common stocks on the main and the secondary boards by
excluding preferred stocks, investment funds, unit trusts, exchange traded funds, and
over-the-counter stocks in the index. The reason of the exclusion of preferred stocks,

32

unit trusts, exchange traded funds and over-the-counter stocks is due to their
performance may be influenced by specific factors that are different than those of
common stocks in general. For instance, preferred stocks have privilege when it
comes to the payment of dividends. In the event of a companys liquidation, preferred
stockholders get paid before those who own common stocks. In addition, in case of
bankruptcy, preferred stockholders have priority distribution of the companys assets,
whereas common stockholders dont receive companys assets unless all preferred
stockholders have been compensated. Secondly, following Ding et al. (2005), the
newly added firms (IPO stocks) are excluded since they lack of available data and are
more volatile and unpredictable than stocks in general. This study does not include
IPO companies which went public in 2008 since the behavior of IPO stocks cannot be
a reliable measure of market anomalies. The number of remaining stocks in each
portfolio in every formation period, after using the selection criteria, is changing over
time due to the development of the financial market.
8
However, the minimum number
of stocks represents each portfolio in every formation period is ten stocks.
9
In the
beginning of the sample period, only 59 stocks are included in the sample. As of
December 2008, the entire sample includes 351 companies (excludes the IPO stocks
in 2008).

The monthly returns data and the monthly accounting data are collected from
DataStream and Thomson Financial. As stated before, further detailes of all the
variables are presented in Table I. The accounting data consists of Book-to-Market
Equity ratio (BE/ME), Earnings to Price ratio (E/P), Cash Flow to Price ratio (CF/P),
market value of equity (ME), and trading volume. The proxy for risk-free interest rate
is Indonesias Government one-month deposit rate. This monthly series of interest
rate are taken from the publication of Indonesia Central Bank.

8
It should be noted that different number of stocks in each year can influence the performance of
market anomalies since early sample period is comprised of insignificant number of stocks.
9
The exceptions are for portfolio zero which depends on the negative value in stock characteristics and
for portfolios in two-independent sort strategies.

33

3. Methodology
Firstly, this section will explain how to investigate the existence of the value premium
using individual sorting. The procedures in portfolios formation are as follows:
Following Lakonishok, Shleifer, and Vishny (1994), at the end of each December
between 1991 and 2008, stocks are ranked in ascending order based on BE/ME, E/P,
and CF/P into quintiles. Therefore there are three different ranks and in total there are
15 portfolios (five quintiles for each stocks rank). In this study, these 15 portfolios are
called the LSV portfolios. The first quintiles are signed for glamour stocks (lowest
BE/MEs, E/Ps, and CF/Ps), the second quintiles are the next glamour stocks, and the
fifth quintiles refer to value stocks (highest BE/MEs, E/Ps, and CF/Ps). Since all the
accounting data except BE/ME are obtained in the form of P/E, and P/CF, the inverse
of all those accounting data is taken in order to make the rank of quintiles for glamour
and value stocks. In addition, following Fama and French (1992), portfolio zero is
formed for stocks that have negative value on BE/ME, E/P, and CF/P. Consequently,
there are three portfolios zero (one portfolio zero for each accounting data).

Secondly, in order to investigate the presence of the size effect, similar procedures in
portfolios formation are applied. At the end of each December between 1991 and
2008, stocks are ranked in desscending order based on market capitalization (ME) into
quintiles. Consequently, there are five size portfolios. The first quintile consists of
stocks with the highest market capitalization (big stocks) and the fifth quintile
comprised of stocks with the lowest market capitalization (small stocks).

The rank for both LSV portfolios and size portfolios are rebalanced every December.
This study utilizes an annual buy and hold strategy and presents both equal-weighted
and value-weighted average monthly returns. The use of value-weighted average
monthly returns is reasonable since stocks with larger market capitalization should
rationally represent a larger portion of the portfolio returns. The weigh of the value-
weighted portfolios is based on the stocks market capitalization at the end of the
formation period. Using equal-weighted returns might also present problems as some
stocks may have a relatively small market capitalization, where an absurd situation of

34

buying more than the stocks available market capitalization could arise. Loughran
(1997) finds that, for U.S. stocks, the value premium persists but is decreased when
value-weighted returns are used.

Now, I will explain the procedures to calculate the average monthly returns for each
of both LSV and size portfolios in order to examine the presence of the value
premium and the size effect. The average monthly stocks returns in each quintiles
portfolios are computed for Years +1, +2,, +5 relative to the time formation.
Specifically, the computation process is as follows: I calculate the average monthly
returns for one-year holding period from December in year to December in year +
1, the average monthly returns for two-year holding period with one portfolio
rebalancing in December in year + 1, the average monthly returns for three-year
holding period with two rebalancing in December in year + 1, and + 2, the
average monthly returns for four-year holding period with three rebalancing in
December in year + 1, + 2, anu + S, and finally the average monthly returns for
five-year holding period with four rebalancing in December in year + 1, + 2, +
S anu + 4. In order to be included in the portfolio for a given year (particular
formation period), a stock must have the accounting data on that portfolio-formation
variables only for that particular formation period when the buy and hold strategy is
conducted. The results for the value premium with individual sorting are summarized
in Table III and the results for the size effect are presented in Table V.

This section continues to explain the procedures to observe the value premium using
the two-independent sort strategies; sorting stocks independently using two
accounting variables. Sorting stocks based on only one characteristic may not fully
capture the anomalies being studied. Lakonishok et al. (1994) argue that sorting
stocks on two accounting variables more accurately distinguishes between strong and
distressed stocks, and produces larger spreads in average returns. Portfolios sorted on
two different stock characteristics are analyzed since stocks may have different
growth rate performance in the past and in the future. CF/P and E/P are used as a
proxy for future expected growth rate, while BE/ME is used as a proxy for past
growth rate. Value stocks are defined as stocks which have low growth in the past

35

(high BE/ME) and are expected by the market to continue growing slowly (high CF/P
and high E/P); the reverse is true for glamour stocks. The procedures to perform the
two-independent sort strategies are as follows. Firstly, stocks are independently sorted
into three portfolios (bottom 30 percent, medium 40 percent, and top 30 percent) by
BE/ME and by CF/P; then by BE/ME and by E/P, and then take the intersections
resulting from the two classifications. The results are nine sets portfolios for each of
two-independent sort methods. The average monthly returns of each portfolio are
calculated with same procedure as that of one-sort classification portfolio. The results
of two-independent sort strategies are summarized in Table IV.

Furthermore, this section explains the procedures to observe and to measure the
existence of momentum versus contrarian. In examining momentum and contrarian
strategies, this study uses monthly returns on individual stocks, volume turnover,
number of shares outstanding, and market capitalizations. The decision to use the
level of trading activity is relevant for emerging markets where thin trading is more
prevalent. Chordia and Swaminathan (2000) indicate that trading volume is a
significant determinant of the cross-autocorrelation patterns in stock returns. Hameed
and Ting (2000) argue that there are two measures of trading to gauge the level of
trading activity for security over year 1:
a. average daily trading volume, u
t
, where u
t
= number of shares traded in year
1 divided by number of trading days in year 1; and
b. Percentage of days stocks was traded,
t
, where
t
= number of days share
was traded in year 1/ number of trading days in year 1.
The first measure,u
t
, gives an indication of how heavily security is traded in the
market on an average day during year 1. A low value of u
t
suggests that the
security is thinly traded, while a high value of u
t
indicates a heavily traded security.
The second measure,
t
, indicates how frequently the security is traded during the
year. A low value of
t
suggests that security is infrequently traded, while a high
value means that security is frequently traded.


36

This research however, will use the lagged monthly trading volume as defined by
McInish et al. (2008).
10
McInish et al. (2008) measure trading volume based on the
turnover ratio (number of shares traded divided by number of shares outstanding)
instead of the simple raw volume. The use of monthly return is to avoid non-
synchronous trading and to alleviate concerns of non-trading. The decision to use
trading volume turnover instead of the raw volume is to disentangle the effect of firm
size from trading volume, as argued by Chordia and Swaminathan (2000) that raw
trading volume is highly correlated with firm size.

In evaluating momentum and contrarian strategies, this study will use two different
methodologies which are Lo and MacKinlay (1990) methodology and Jegadeesh and
Titman (1993) methodology. Jegadeesh and Titman (1993) methodology is presented
in section V, in the robustness check.

In this section, I will explain in details the procedures of Lo and MacKinlay (1990)
methodology. The investment strategy is to buy stocks in proportion to their returns
over the ranking period. In the momentum strategy, the investor takes a long position
in positive-past return stocks, with higher weight on top performers and at the same
time the investor takes a short position in negative-past return stocks, with higher
weight on bottom performers. On the other hand, on the contrarian strategy, the
investor takes a long position in negative-past return stocks, with higher weight on
bottom performers and at the same time, investor takes a short position in positive-
past return stocks, with higher weight on top performers.

Stocks are classified as winner if their average returns during the formation period
outperform those of the market (
P
t

mP
t
) > u.
11
While losers refer to those that
underperform the market during the formation period. F refers to formation periods
and H refers to holding periods.

10
Lagged trading volume refers to trading volume during the formation period. Lagged trading volume
and trading volume are used interchangeably. If not stated otherwise, trading volume means lagged
trading volume.
11
Market return refers to equal-weighted return of all stocks available () during the formation period;
the remaining of the stocks after performing the selection criteria.

37

During each study period t, each stock is assigned a weight of

t
= (
1
N
)|
P
t

mP
t
] (6)

Where
P
t
=
1
P
_
,s
t-1
s=t-P
, is the average returns of stock during the formation
period from to 1 and
mP
t
=
1
P
_
m,s
t-1
s=t-P
,is the market average returns
during the formation period from to 1, and is the number of stocks in the
sample in each formation period. The profit of the investment strategy, denoted as n
t
,
is

n
t
= _
t
N
=1
H
t
(7)

Where
H
t
=
1
H
_
,s
t+H-1
s=t
, the average returns of stock during the holding period
from to + E 1. The procedures are as follows: at the beginning of each month ,
JKSE stocks are assigned to winners/losers based on their performance during the
formation period from time to 1. A stock that has average return higher than
market return during the formation period is classified as winner and will be assigned
a positive weight by construction. Conversely, those which have average returns
lower than the market return will be considered as losers and get negative weight by
construction. The larger the difference (whether it is positive or negative) between
stocks past-average returns and market return, the larger the weight assigned to that
particular stock. Therefore, stock with higher past-average returns has larger portion
in the portfolio. Momentum/ Contrarian profits are the stocks average returns during
the holding period from to + E 1 times their weight. For simplicity, this study
implements strategies for which the length of the formation and the length of holding
period are the same. For example, F/H: 1/1 months, 3/3 months, 6/6 months, and
12/12 months. Because of the length of the sample period, this study concentrates
only on patterns in medium-term returns. The procedure can be illustrated as follows,
in a 3/3 strategy, at the beginning of December 1991 (), stocks are classified as
winners/losers based on their average monthly returns from September 1991 ( )

38

to November 1991 ( 1). If the past-3 months average returns of stock is higher
than the market return, then stock is classified as winner; otherwise loser. Finally,
momentum/ contrarian returns are computed by multiplying the weight and the
average returns from December 1991() to February 1992 ( + E 1). Portfolios are
rebalanced every month. In addition, to increase the power of the analysis, the
strategies include portfolios with overlapping holding periods.

A positive value of n
t
indicates momentum profit. On the other hand, since a
contrarian portfolio has a short position for winners and a long position for losers, a
negative value of n
t
reflects contrarian profit. This strategy will lead to a zero-cost
portfolio since,

t
N
=1
= u

Therefore the strategy used in this research can be seen as a zero-investment strategy
in which momentum strategy will buy winner and short loser, whereas contrarian
strategy will buy loser and sell winner. The results of momentum and contrarian
strategy using Lo and MacKinlay (1990) methodology are provided in Table VI.

The employed methodology (Lo and MacKinlay (1990)) differs from previous studies
in term of the weighing process. Common past researches, defined winners/losers for
stocks that fall into the highest/lowest rank in the formation periods (e.g., Jegadeesh
and Titman (1993)). Consequently, stocks that are classified as winners do not
necessarily outperform the market. The weighing process in this research therefore
gives clearer picture of winner and loser stocks as well as provides better momentum
and contrarian strategy. However, in order to give comprehensive evidences,
momentum versus contrarian strategy using Jegadeesh and Titman (1993)
methodology is also presented in the robustness check section.

This section continues to explain the procedure to measure the performance of
momentum and contrarian strategies using Lo and MacKinlay (1990) methodology
that incorporates trading volume. Firstly, JKSE stocks are sorted into three groups

39

(High, Medium and Low trading volume) based on their lagged trading volume.
Secondly, within each volume group, stocks are classified as winner/loser and
momentum/contrarian profit are calculated using the same procedure as explained
above. The results of momentum versus contrarian strategy that incorporates trading
volume are presented in Table VII. It should be noted that the volume classification of
this study is different from that of Conrad, Hameed, and Niden (1994), who assigned
stocks into high and low volume groups based on whether the trading volume in the
formation period is higher or lower than its historical average. Following Hameed and
Ting (2000), this study argues that the procedure of volume classification in this study
is more appropriate in capturing different stocks behavior in different trading activity
levels especially in Indonesian stock market where thin trading is more prevalent. For
example, using Conrad et al. (1994) methodology, stocks is assigned to high volume
group, could represent thinly traded stocks in a particular formation period.
Conversely, stocks classified as low volume compare to their historical average, might
be heavily traded in the particular formation period, relative to other stocks in the
market.

4. Time- Series Return Regression
In order to examine whether the simple asset pricing model is able to explain the
existence of three well known market anomalies in Indonesian stock market,the
CAPM time series regression are tested to three groups of portfolios. The time-series
regressions are conducted using Eviews version 3.1. These groups of portfolios are (1)
Fama French 25 size-BE/ME portfolios; (2) Lakonishok Shleifer and Vishny (LSV)
Portfolios; and (3) Portfolios formed based on past returns.

The Fama French 25 size-BE/ME portfolios basically represents portfolios that
combine value and size characteristics. The 25 size-BE/ME portfolios are used to
investigate whether the simple asset pricing model can capture the return variations in
each portfolios with specific stock characteristic. For instance, whether the return
variation in portfolio that consists of stock with the smallest market capitalization and
the highest BE/ME is captured by the CAPM. In addition, the 25 size-BE/ME

40

portfolios are also used to capture the return variations in portfolios of stocks that are
ranked based on BE/ME, controlling for size and to capture the return variations in
portfolios of stocks that are ranked based on size, controlling for BE/ME. LSV
portfolios, on the other hand, are portfolios that use three value characteristics
(BE/ME, E/P, and CF/P) as proxies to differentiate between value and growth stocks.
If the CAPM do explain the return variations in LSV portfolios, the estimated
intercepts in each quintiles should be statistically not different from zero. Finally,
portfolios based on past returns are used to examine whether the CAPM can explain
momentum versus contrarian pattern.

This study observes the traditional Sharpe-Lintner CAPM as explained in the previous
section (equation 5), where the monthly excess returns of three groups of portfolios
are regressed against the monthly excess market return:

]
= o + |
Mt

]
][
M
+ e
t
(8)

Where:
t
refers to the average monthly returns of portfolio at time .
]
refers to the one-month deposit rate.
12

]
refers to the average monthly excess returns of portfolio at time .
Mt
refers to the value-weighted monthly returns of all stocks in the portfolios at time
with the inclusion of the negative BE stocks that are excluded in forming the 25
size-BE/ME portfolios and the LSV portfolios.
13

Firstly, this part explains the procedure of the CAPM time-series regressions on the
Fama French 25 size-BE/ME portfolios. The Fama French 25 size-BE/ME portfolios
are formed as follows. At the end of each month each year t (1991-2008), JKSE
stocks are allocated to five size groups (small, 2, 3, 4, big) based on their market

12
In this study, the Indonesian Government one-month deposit rate is used as a proxy of one-month
Treasury bill rate used in the common studies.
13
For LSV portfolios and portfolios formed based on past returns,
Mt
refers to the equal-weighted
monthly returns of all stocks in the portfolios since the monthly returns of both LSV portfolios and
portfolios formed based on past returns are also calculated based on equal-weighted monthly returns.

41

capitalization at the end of that particular month. Size small refers to stocks that fall
into the lowest 20 percent rank of market capitalization and size big refers to stocks
that belong to the highest 20 percent rank in market capitalizaton. JKSE stocks are
also sorted independently to five BE/ME groups (Low, 2, 3, 4, high) based on the
quintiles breakpoints. Low refers to stocks that have the lowest 20 percent rank in the
BE/ME and high refers to those that have the highest 20 percent rank in the BE/ME.
The 25 size-BE/ME portfolios (Small/Low, Small/High, . . . , Big/Low, Big/High) are
formed from the intersections of the five size groups and the five BE/ME groups. In
the same manner as before, stocks with negative value in BE are excluded when
forming the intersections of size-BE/ME portfolios.
14
Value-weight monthly returns
on the portfolios are calculated from the beginning of month t+1. These value-
weighted monthly excess return of the 25 portfolios are regressed against the monthly
excess market returns. The results of the CAPM time-series regression on the Fama
French 25 size-BE/ME portfolios are summarized in Table VIII.

Secondly, this part continues by explaining the CAPM time-series regression
procedure for LSV portfolios. The LSV portfolios are formed as follows. At the end
of the month each year (1991-2008), JKSE stocks are allocated to five portfolios,
based on the quintiles breakpoints of BE/ME, E/P, and CF/P. Therefore there are three
different ranks and 15 portfolios in total (5 quintile for each rank). The sample of
stocks is the same for all the fundamental characteristics since in order to be included
in the portfolios in a given year, a stock must have data on all the characteristics used
to form the portfolios in that particular formation period. Equal-weight monthly
returns are calculated from month + 1, resulting in a time series of 205 monthly
returns from December 1991 to December 2008.
15
These equal-weighted monthly
excess return of the 15 portfolios (five portfolios for each stock characteristic) are
regressed against the monthly excess market returns. The results of the CAPM time-
series regression on the LSV portfolios are summarized in Table IX.

14
Basu (1977) shows that the exclusion of firms with negative valuation ratios will have minimum
impact on portfolio returns.
15
Due to data availability, the sample period for CF/P portfolios begins on December 1991 and ends on
December 2007, resulting in a time series of 193 monthly returns.

42

Thirdly, the procedure in forming portfolios based on past returns are provided below.
At the beginning of each month , JKSE stocks are allocated to quintiles based on
their average monthly returns between months 12 to 2. For example, stocks
are allocated to the 12-2 portfolios for December 1992 based on their average returns
from December 1991 to October 1992. Quintile 1 refers to stocks with the lowest past
average monthly returns. Quintile 5 refers to stocks with the highest past average
monthly returns. The portfolios are reformed monthly, and the equal-weight simple
monthly returns in excess of the one-month deposit rate are calculated from December
1992 to January 2008. These equal-weighted monthly excess return of the 5 quintiles
are regressed against the monthly excess market returns. The results of the CAPM
time-series regression on the portfolios formed based on past returns are summarized
in Table X.

The Sharpe-Lintner CAPM predicts that o should be zero since the variation in excess
stock returns can be explained by the variation in [. However, many researches find
that CAPM fails to explain the patterns in average stocks returns. The unexplained
patterns are typically called market anomalies.

This section continues to explain the procedure of the time-series regressions using
the Fama French three-factor model. If the CAPM fails to explain stock returns
variation, it is argued that there might be other variables that should be included in the
model. As evidenced by Fama and French (1996), the Fama French three-factor
model is able to better capture the unexplained market anomalies. Therefore, I will
also perform the time-series regressions using the Fama French three-factor model to
the three groups of portfolios. The Fama and French three-factor model suggests that
the return on a portfolio in excess of the risk-free rate is explained by the sensitivity of
its return to three factors which are: (i) the excess market return (
m

]
); (ii) the
difference between the return on a portfolio of small stocks and the return on a
portfolio of large stocks (SMB-Small minus big); (iii) the difference between the
return on a portfolio of high book-to-market stocks and the return on a portfolio of

43

low book-to-market stocks (HML-High minus low). Specifically, the excess return on
portfolio is,

]
= o + |
Mt

]
]b
+ s
H +
EHI + e
t
(9)

The independent variables SMB and HML are formed as follows. At the end of each
month each year t (1991-2008), JKSE stocks are allocated to two size groups (small or
big, S or B) based on whether their market capitalization at the end of that particular
month is below or above the median market capitalization for JKSE stocks. JKSE
stocks are also sorted independently to three BE/ME groups (Low, medium, or high:
L, M, or H) based on the breakpoints for the bottom 30 percent, middle 40 percent,
and top 30 percent of the values of BE/ME for JKSE stocks. Six size-BE/ME
portfolios (S/L, S/M, S/H, B/L, B/M, and B/H) are formed from the intersections of
the two sizes and the three BE/ME groups. Value-weight monthly returns on the
portfolios are calculated from the beginning of month t+1. SMB is the difference,
each month, between the average of the returns on the three small-stock portfolios
(S/L, S/M, and S/H) and the average of the returns on the three big-stock portfolios
(B/L, B/M, and B/H). HML is the difference, each month, between the average of the
returns on the two high-BE/ME portfolios (S/H and B/H) and the average of the
returns on the two low-BE/ME portfolios (S/L and B/L).

Following Fama and French (1996), in this study, the 25 Fama French Size-BE/ME
portfolios, LSV portfolios, and portfolios formed based on past returns are regressed
using the Fama French three-factor model. Finally, the GRS tests are calculated for
each portfolio.

5. The GRS Test
CAPM imposes a cross-sectional restriction that expected asset returns are linearly
related to their market beta. In other words, there is a linear relationship in which beta
explains fully the cross-sectional variation in expected returns. In addition to beta,

44

there is no other variable which can explain expected returns. Therefore, the CAPM
(equation 8) implies that the intercepts o
in time-series regressions for each asset

r
t
= o
r
Mt
[
M
+ e
t
, = 1 (10)

are all zero. The restriction states that all o
need to be zero, not just some of them

and not only the sum _ o

should be zero (the average intercept is zero). Since from
the empirical tests, we can only estimate o
, which will be different from zero, we

need a joint test whether all o
s = 0.

Gibbons, Ross, and Shanken (1989) introduce the test of joint hypothesis of o
. They
propose a statistical test of whether every single element in the ( 1)- dimensional
vector o (i.e., the vector of time-series intercepts) equal zero. Specifically, GRS is a
finite sample test on whether the estimated s (o
i
) from the time-series regressions
are jointly zero.

According to Gibbons, Ross and Shanken (1989), GRS test statistic can be written as:
N
= _
] _
I
I 1
]
o
i

-1
o
1 + p
-1
p
~(, I)
Where,
o is a 1 vector of estimated intercepts.
`
is an unibiased estimate of the residual covariance matrix.
p is a I 1 vector of the factor portfolios sample means.
is an unbiased estimate of the factor portfolios covariance matrix.

Alternatively, GRS can also be used to test the differences in (ex-post) Sharpe Ratios
or shifts in the efficient set. Gibbons, Ross, and Shanken (1989) show that the
expression above can be rewritten as


45

N
= _
] _
I
I 1
]
_
p
q
o
q
]
2
_
p
L
o
L
]
2
1 + _
p
L
o
L
]
2

Where the portfolio q is the ex-post tangency portfolio
16
constructed from the
assets and the I factor portfolios (in CAPM, I is the market portfolio). If I is ex-post
efficient, it will have the highest Sharpe Ratio of all portfolios which can be
constructed and it will have the same Sharpe Ratio as q (where I is included).
Otherwise, q will have higher Sharpet Ratio since with combination of the test
assets, it can do better than with I alone. Therefore, I ex-ante efficient does not
necessarily ex-post efficient. The difference in realized, squared Sharpe Ratios,
however should not be too much as q is much more efficient than I. The GRS
statistic,
N
shows how large can the differences be while the efficiency of I can still
be hold.

The Null-Hypothesis states that

E
0
: o = u
,

If o
s = 0, then the GRS statistic,

N
is statistically not different from zero. The larger
the o
s are in absolute value, the greater the GRS statistic will be and consequently
the larger the chance of rejecting the Null-Hypothesis. With respect to CAPM,
rejecting the Null-Hypothesis of jointly zero o
s means that market portfolio is not

the ex-post most efficient portfolio since the ex-post maximum Sharpe Ratio of
market portfolio is less than the ex-post maximum Sharpe ratio of the market portfolio
and N assets.

16
The ex-post tangency portfolio (the log-portfolio) is the portfolio preferred by an investor with
logarithmic utility, i.e. investor with a unit relative risk aversion (Mertens, 2002).

46

IV. Results
This section provides the evidence of the existence of the value premium, the size
effect, and momentum versus contrarian. I will begin with the simple individual-sort
strategy in forming portfolio based on some stocks characteristics (BE/ME, CF/P, and
E/P) in order to investigate whether value stocks have higher realized average returns
than growth stocks. Then, this study also employs two-independent sort strategy
which combines two stocks characteristics in examining the value premium.
Combining two accounting data are expected to give better picture in the performance
of the value strategies. Furthermore, this section presents the analysis of the results
from momentum versus contrarian using Lo and MacKinlay (1990) methodology
which the procedure has been explained in detail in the previous section. The last part
of this section presents the analysis and summary of momentum versus contrarian
which incorporates trading volume in the analysis.

1. Simple Glamour and Value Strategies
Table III provides the returns on portfolios of stocks that are ranked based on their
BE/ME, CF/P and E/P. In order to give a better picture for investors, this study
exploits an annual buy and hold strategy in contrast to monthly buy and hold strategy
used in most previous study. The annual returns are the average monthly returns.
Because of various market microstructure biases as well as trading costs, annual buy
and hold strategy produces returns that are closer to those that investors can actually
capture.

Table III shows the returns for Years 1 through 5 after the formation periods and the
average annual 5-year returns. The numbers presented in the table are the average
monthly returns over all formation periods. Similar to Lakonishok et al. (1994), the
results in Panel A1 confirm the existence of value premium in Indonesian stock
market. As can be seen, the average annual 5-year returns for low BE/ME stocks
(Glamour) is 0.66 percent, whereas the average return for high BE/ME stocks (Value)
is 4.13 percent resulting in significant difference of 3.47 percent. Looking at Panel

47

A1, 1-year buy and hold value stocks strategy on portfolio formed based on BE/ME
produces the highest possible return for 4.91 percent annually.

Panel B1 of Table III presents the returns of portfolios ranked based on CF/P. Similar
to Panel A1, low CF/P stocks (Glamour) have lower average returns than high CF/P
stocks (Value). High CF/P stocks are regarded as value stocks due to their low prices
per dollar of cash flow. On the other hand, low CF/P stocks are defined as glamour
stocks because of their high expected growth rate on cash flow. The average returns
for high CF/P stocks is 2.39 percent and for low CF/P stocks is 1.94 percent. The
difference of 0.45 percent annually however, is not significant compare to that of
BE/ME. In contrast with Lakonishok et al. (1994), sorting on CF/P appears to produce
lower spread in returns than sorting on BE/ME. The highest possible average return of
portfolio formed based on CF/P is 2.98 percent, which can be obtained by performing
a 2-year buy and hold value stocks strategy.

Basu (1977), Jaffe et al. (1989), and Fama and French (1992, 1996) find that stocks
with low P/E can generate positive abnormal returns.
17
Table III, Panel C1 shows the
results of annual buy and hold strategy for portfolios ranked based on E/P. On
average, high E/P stocks have an annual return of 3.42 percent whereas low E/P
stocks have an annual return of 1.32 percent. High E/P stocks outperform low E/P
stocks by a fairly wide margin, although the difference is not as large as that of
BE/ME. Similar with BE/ME portfolios, the highest possible average returns investors
can earned is by utilizing a 1-year buy and hold value stocks strategy.

Table III, Panel A2, B2, and C2 provide the results of same strategies using value-
weighted returns. In line with Heston, Rouwenhorst, and Wessels (1995) and
Loughran (1997), this study finds that when value-weighted returns are used, the
spreads and the magnitudes decrease by a significant portion. On average, high
BE/ME stocks produce an annual return of 0.13 percent. Conversely, low BE/ME
stocks have on average an annual return of 0.04 percent. The results still support the

17
All the ratios presented in this research are defined as the stocks characteristic divided by market
value of equity. For example, E/P is the inverse of P/E that is commonly used in past researches.

48

existence of value premium in Indonesian stock market except for portfolios ranked
on CF/P. In Panel B2, using value-weighted returns, on average, high CF/P stocks
underperform low CF/P stocks by 0.03 percent annually. In the value-weighted
scenario, in portfolios formed based on other than CF/P, this study discovered that a
1-year buy and hold value stocks is still the most profitable strategy.

In line with Fama and French (1992), the average returns for portfolio zero are high,
some even higher than the average returns of portfolio five (value). The evidences of
value-weighted returns in Panel A2, B2, and C2 show that portfolio zero outperforms
value portfolio by a considerable amount. For example, negative BE (i.e. which
results from persistently negative earnings) and high BE/ME (which typically means
that stock prices have declined) are both signals of poor earnings prospects. The
finding that negative BE and high BE/ME stocks have on average higher returns than
low BE/ME stocks is consistent with the Fama and French hypothesis that BE/ME is a
proxy of relative distress.

In conclusion, this study argues that value premium exists in Indonesian stock market
during the sample period. This finding can add evidence to deny the argument that
value premium in U.S. market is a result of data mining. Utilizing the fact that value
premium does exist in Indonesia, investors can benefit from performing a 1-year buy
and hold value stocks formed on the basis of BE/ME and E/P.

2. Two- Independent Sort Glamour and Value Strategies
According to behavioral model, Kahneman and Tversky (1982) explain that compared
to value stocks, glamour stocks are those that have higher recent and expected growth
rates in earnings. They argue that investors tend to overreact to recent information and
make extreme predictions based on the information which reliability and predictive
validity are known to be low. Chan, Karceski, and Lakonishok (2003) argue that
investors and analysts behavior in favor of growth stocks drive their prices up and
cause the overvaluation of glamour stocks.


49

Lakonishok et al. (1994) explore a contrarian strategy which sells stocks with high
past growth as well as high expected future growth and buys stocks with low past
growth as well as low expected future growth. They refer to both CF/P and E/P as a
proxy for expected growth rate whereas BE/ME ratio is used as a proxy for past
growth. The contrarian strategy exploits sorting stocks independently based on their
past growth as well as their expected growth rate. Panel A1 in Table IV, presents the
results for contrarian strategy that sorts stocks based on both BE/ME and E/P. In order
to avoid an insignificant number of stocks in each group of portfolios, stocks are
sorted into three instead of five portfolios as in individual-sort strategy. Accordingly,
in this study, stocks are sorted independently into three groups (bottom 30 percent,
middle 40 percent, and top 30 percent) by BE/ME and E/P, and then take the
intersections between three BE/ME groups and three E/P groups. Glamour stocks are
those which fall into bottom 30 percent in both BE/ME and E/P groups. Value stocks,
on the other hand, are those that belong to top 30 percent of both BE/ME and E/P
groups.

Based on Table IV, Panel A1, the growth portfolios have a return of 1.32 percent and
the value portfolios have on average, a return of 3.04 percent. On average, in this
sample period, value stocks outperform growth stocks by 1.72 percent annually. As
can be seen in Panel A1, moving horizontally from glamour portfolios to value
portfolios, the average annual returns are increasing even though not necessarily
monotonically. For example, high BE/ME stocks with low expected future growth
rate (intersection BE/ME-E/P, 3-2), which are not defined as value stocks, have an
average annual return of 2.73 percent, whereas high BE/ME stocks with low expected
future growth rate (intersection BE/ME-E/P, 3-3), which are defined as value stocks,
have a higher average annual return of 3.04 percent. The reason of no exact increasing
pattern in the average returns might be related by individual stocks unsystematic
factors within each group of portfolios. This unsystematic factors, for example can be
a macroeconomic event that give impact to particular industry. Consequently, the
impact to each group of portfolios might be different. The highest average returns is
3.74 percent which can be obtained by buying and holding stocks that fall in the
intersection of BE/ME-E/P, 3-1. In other words, those are stocks with lowest past

50

growth rates and highest expected future growth rates (the highest BE/ME and the
lowest E/P.

Table IV, Panel B1 shows the results of two-independent sort based on BE/ME and
CF/P. Controlling for BE/ME, high CF/P stocks do not necessarily have higher
average returns than lower CF/P stocks. For example, the average return of stocks that
belong to portfolio BE/ME-CF/P; 3-1, which is not considered as value stocks, is
higher than the average return of portfolio BE/ME-CF/P; 3-3, which is considered as
value stocks. The difference in annual average return between the extreme portfolios
is 1.82 percent with value portfolio has an annual average return of 2.96 percent and
glamour portfolio has an average return of 1.14 percent. The highest possible return
can be achieved using a strategy that buy stocks with lowest past growth and highest
expected future growth rates (intersection BE/ME-CF/P, 3-1), resulting in an average
annual return of 4.02 percent.

Table IV, Panel A2 and B2 provide the results of two-independent sort strategy with
value-weighted returns. In two-independent sort strategy using BE/ME-E/P as well as
BE/ME-CF/P, value portfolios outperform glamour portfolios by approximately 0.08
percent. Similar to the individual-sort strategy in Table III, the magnitude of value-
weighed annual average return is smaller than that of equal-weighed annual average
return. In line with Lakonishok et al. (1994), using value-weighed returns, two-
independent sort strategy produces substantially higher returns than either the BE/ME
and CF/P or the BE/ME and E/P strategy alone. For example, on the BE/ME-E/P
strategy, among portfolios of stocks with the lowest BE/ME ratios, the average annual
return varies from 0.08 percent for stocks with the highest expected growth rates to
0.98 percent for stocks with the lowest expected growth rates. The individual BE/ME
strategy, on the other hand, produces an average annual return of only 0.04 percent for
stocks in the lowest BE/ME quintiles. In the value-weighed scenario of two-
independent sort strategy based on BE/ME and E/P, this study found that stocks with
the highest past growth rates and the lowest expected future growth rates yield highest
average returns.


51

Overall, the results of two-independent sort strategy can be summarized as follows.
Firstly, two-independent sort value strategies, especially those which incorporate
equal-weighted return, produce higher returns than those of similarly constructed
glamour strategies for the sample period beginning in December 1991 and ending in
December 2008. Secondly, the results show that the highest possible average annual
return can be achieved by buying stocks with lowest past growth and highest expected
growth rates proxy by E/P. Thirdly, two-independent sort strategies, especially those
which incorporate value-weighted return, produce higher average annual return than
those strategies based exclusively on individual-sort. Fourthly, within two-
independent sort strategies using BE/ME and CF/P, the highest average return is
obtained by buying and holding stocks that belong to the portfolio with the highest
past growth and lowest expected growth rates proxy by CF/P. Last but not least,
investors should conduct an additional analysis when making investment decision
based on the evidences above since value stocks as a group do not outperform growth
stocks in every observation. The reason of non-monotonically pattern found in Table
IV is subject to further investigations.

3. The Size Effect
Table V shows the returns of portfolios of stocks that are sorted on the market value
of equity. Glamour stocks refer to those in the highest ME quintiles, whereas value
stocks are those that belong to the lowest ME quintiles. As can be seen in Panel A,
small stocks have on average an annual return of 3 percent; outperform large stocks
by 1.51 percent per year. The results are in accordance with Banz (1981), who argued
that smaller firms have had, on average, higher returns than larger firms. The results
for value-weighted returns can be seen on Table V, Panel B. The average value-
weighted returns of value stocks outperform those of growth stocks in all the holding
periods. However, it should be noted that the analysis in this study has not incorporate
transaction cost. Therefore, by looking at the magnitude of average value-weighted
returns of value stocks, it is clear that investors cannot earn abnormal returns.


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4. Momentum versus Contrarian Strategies
Chan, Jegadeesh and Lakonishok (1999) argue that in medium term (up to 12 months)
stock prices exhibit momentum (continuation in a price direction). In other words, for
these horizons, what goes up tends to keep rising and vice versa. However, the
evidence in Table VI opposes their hypothesis. As can be seen in all F/H strategies,
losers have higher average returns than winner portfolios. Consequently, zero-cost
strategies that buy winners and sell losers, ended up in negative average returns. It
must be noted that negative returns using this methodology mean contrarian profits.

The evidence of winner and loser in all F/H strategies is in line with the argument that
winner and loser do not have the same price movement. Contrary to T.H. McInish et
al. (2008), this study suggests that winners display momentum behavior, whereas
losers experience reversal within the sample period. Winner portfolio continues to
earn positive profits up to 12 months holding periods. On the other hand, loser
portfolio shows some overreaction up to 12 months holding periods, although the
magnitude of both reversal and continuation decline as the length of F and H increase.
These findings can possibly be attributed to the up-market effects during the study
period. For example, if most of monthly returns in the study period are positive, it is
by design that positive-return stocks will exhibit momentum and negative-return
stocks will experience reversal. Nevertheless, since the Asian crises in which stock
market index decreased significantly are included in the whole sample period, the
results are robust against the up-market effects.

Overall, since the medium-term average returns of losers are higher than winners,
investors who trade in Indonesia stock markets can generate profit by performing a
contrarian strategy. The results seem to suggest that in Indonesia, the overreaction
effect towards losers is so significant that the reversal effect in losers exist longer (up
to 12 months). On the other hand, the overreaction behavior towards winners is not
significant enough to drive the prices remarkably high. As a consequence, the
contrarian profit in losers is higher than the momentum profit in winners, even though
they both decline as the length of F and H increase.

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5. Effect of Trading Volume on Momentum/ Contrarian Profit
In this subsection, the role of trading volume is examined in momentum/contrarian
strategy. Several researches confirm the relation between volume and predictable
patterns in short-term stock returns. Blume, Easley, and OHara (1994) argue that
traders who use information contained in the volume statistic will do better than
traders who do not. In accordance with the premise that the predictability of short-
term returns might be affected by trading volume, this study examines whether lagged
trading volume could affect the momentum/ contrarian profits.

The procedures in portfolios formation and the computation of returns are explained
in section III. The results of the effect of lagged trading volume to momentum/
contrarian profits are shown in Table VII. As can be seen from Table VII, the result in
1/1 strategy contradicts the prediction of Conrad, Hameed, and Niden (1994) and Lee
and Swaminathan (2000). Conrad et al. (1994) argue that high volume stocks show
reversal behavior whereas low volume stocks display momentum pattern. Chordia and
Swaminathan (2000) also provide the evidence that low volume stocks tend to adjust
more slowly than high volume stocks to information shocks. The under-reaction of
low volume stocks results in momentum pattern, while the overreaction in high
volume stocks results in contrarian pattern. The evidences in Table VII however,
show that across volume groups, stocks experience reversal pattern. These results are
in part similar with those of Hameed and Ting (2000). They observe that both high
and low volume groups produce contrarian profit, the magnitude however is larger for
high volume groups. Comparing the results in Table VII with those in Table VI, it is
indicated that price reversal is even lower following an increase in trading volume. As
an exception, in 1/1 strategy, despite statistically insignificant, the average returns of
winner stocks in high trading volume group are higher than those of loser stocks.
Consequently, a zero-cost momentum strategy that buys winner and sells loser will
result in momentum profit. 12/12 strategy is in favor of contrarian strategy as the
results show that in all trading volume groups, zero-cost strategies have negative
average returns. As previously stated, in this research negative return means
contrarian profit.

54

The price movement of both winners and losers are similar with those in Table VI.
These findings confirm the results of Fung, Leung and Patterson (1999) that winners
exhibit momentum and losers exhibit reversal. In 1/1 strategy, moving on to higher
volume groups, the momentum profit in winner increases (from 0.12 percent to 0.35
percent) while the contrarian profit in loser decreases (from -0.29 percent to -0.24
percent). In 12/12 strategy, the amount of momentum profit in winner and contrarian
profit in loser are not significantly different across volume groups.

In short, there is no significant difference in the behavior of zero-cost strategies across
volume groups. Using 12/12 zero-cost strategies, Indonesian stock market exhibits no
clear pattern of the effect of trading volume on momentum/contrarian profits. On the
other hand, using 1/1 zero-cost strategies, most of the average returns are statistically
insignificant. All volume groups display reversal pattern and the magnitude of
reversal is higher for low volume groups


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V. Robustness Check
To examine whether stocks fundamental characteristics are priced in an explicit asset-
pricing model, this section begins by documenting the simple CAPM time-series
regressions. The Sharpe-Lintner versions of the CAPM that is used in this study share
the prediction that the market portfolio is mean-variance efficient. Implicitly, the
differences in the expected return across securities and portfolios are entirely captured
by the differences in market beta. From the results, it was discovered that the CAPM
captures most of the returns variation, except for the small value portfolios which
have alpha that is statistically not different from zero.
18
However, the results of the
GRS test accepts the null hypothesis that alphas are jointly zero. In order to provide
more robust findings, following Fama and French (1996), this study also performs the
time-series regressions using the Fama French three factor model. Fama and French
(1992) provide evidences that ME and BE/ME capture much of the variation in stock
returns. They argue that if stocks are rationally priced, systematic differences in
average returns are due to differences in risk. Consequently, in rational pricing
condition, size (ME) and BE/ME must proxy for sensitivity to common risk factors in
returns. Fama and French (1996) suggest that the three-factor model, which is
constructed to mimic risk factors related to size and BE/ME, may explain the
variation of stock returns. Their three factors are as explained in section III. The
results of the regressions using the Fama French three-factor model however, do not
add any significant improvement to the performance of the simple CAPM.

1. Simple CAPM Time-Series Regressions
a. Fama French 25 Size-BE/ME portfolios
The procedures to form the 25 size-BE/ME portfolios as well as the variables used in
the regressions are explained fully in section III. From December 1991 to December
2008, there are 205 monthly observations. Table VIII shows the results of the CAPM
regression on Fama French 25 size-BE/ME portfolios. In the CAPM world, the true

18
It should be noted that this study utilizes the simple CAPM with constant beta. Academics and
practitioners argue that beta could be time-varying since investors have more than one period
investment horizon. In addition, there might be structural breaks in the stock market in which the
performance of the market anomalies might be changing as well. Further investigation using more
advance test are encouraged.

56

intercepts of the regressions should be zero. As can be seen on Table VIII, the CAPM
regression to explain each of 25 size-BE/ME portfolios produce nearly zero intercepts
and mostly statistically insignificant. The CAPM however, cannot capture the
variation among those small value portfolios. As can be seen on Table VIII in the
upper right corner of the alphas, small size and high BE/ME portfolios have
statistically significant intercepts (-3.22, -3.4, and -3.82). If the simple CAPM holds,
there is no way to group assets into portfolios whose intercepts are reliably different
from zero. For instance, the intercepts for a portfolio of stocks with small size and low
BE/ME and a portfolio of stocks with small size and high BE/ME should both
statistically not different from zero. To complete the analysis, this study jointly tests
the vector of regression intercepts against zero. Table VIII shows the result of the
GRS test which accepts the hypothesis that the CAPM can explain the average returns
on 25 size-BE/ME portfolios at any significance level. Looking at the R
2
table, the
magnitudes of the R
2
suggests that the CAPM, in average, can explain 61 percent of
the variation in monthly excess returns on 25 size-BE/ME portfolios.

Overall, the findings in Table VIII, despite of statistically significant intercepts among
small value portfolios, seem to suggest that the CAPM explains the average returns on
most of the portfolios since the GRS test accept the null hypothesis of jointly zero-
alphas. However, other independent variables might be needed to better capture the
returns variations of small value portfolios. Again, it should be noted that this study
employs the simple CAPM with constant beta and without any structural breaks.
Utilizing more advance test might provide different performance of the CAPM
estimates.

b. LSV Portfolios
Lakonishok et al. (1994) observe that sorting stocks based on some value
characteristics like BE/ME, CF/P, and E/P, then exploit a buy and hold strategy on
value stocks can produce abnormal returns. The complete details of LSV portfolios
formation and the variables used in the time-series regressions are explained in
section III. The sample period uses for BE/ME and E/P portfolios are from December

57

1991 to December 2008, resulting in 205 monthly observations. However, due to data
availability, the sample period for CF/P portfolios begins on December 1991 and ends
on December 2007, resulting in a time series of 193 monthly returns.

Table IX presents the coefficients of the CAPM time-series regressions on monthly
excess returns of portfolios formed based on BE/ME, CF/P, and E/P respectively.
Similar with the 25 size-BE/ME portfolios, the estimated intercepts in portfolios
based on BE/ME are nearly zero and statistically insignificant except for those among
value portfolios. The CAPM does a good job in explaining the return variations in
portfolios based on CF/P, specifically all intercepts are statistically not different from
zero. The exception is for portfolios based on E/P which almost all estimated
intercepts are statistically different from zero. These results also showed in the GRS
test. For portfolios based on CF/P, the null hypothesis is accepted at any significant
level. Despite of some statistically significant intercepts for portfolio based on E/P
and BE/ME, the results of GRS test still accept the null hypothesis of jointly zero-
alphas. The averages R
2
for BE/ME-rank, E/P-rank, and CF/P-rank portfolios are
0.89, 0.89, and 0.91 respectively. High values on R
2
explain that CAPM does a good
job in capturing the variations in the returns of LSV portfolios in this sample period.

In short, the results show that the CAPM fails to capture the return variations in small
value portfolios based on BE/ME and E/P, as evidenced by statistically significant
intercepts. The return variations in all quintiles of CF/P rank are explained by the
CAPM. In overall, despite of some statistically significant intercepts, the GRS test
accept the null hypothesis that the alphas in all portfolios are jointly zero. Again, this
study does not take into account time-varying beta or any structural breaks. Further
research regarding these matters may provide better analysis of the CAPM
performance in explaining market anomalies.

c. Portfolios formed on Past Returns
The steps in forming the portfolios are explained in section III. Since this study
employs a strategy based on 12 months and skips one month prior the ranking period,
the sample period begins on December 1992 and ends on December 2008, resulting in

58

total of 182 monthly observations. Table X provides the results of the CAPM time-
series regressions on portfolios formed based on past returns. This study exploits a
strategy based on 12 months past returns that skip one month prior to the ranking
period. On average, CAPM can capture 90 percent of returns variations. As before,
almost all estimated intercepts are nearly zero and statistically insignificant. The only
exception is for portfolio with the lowest past returns (losers). However, the GRS test
accepts the hypothesis that all intercepts are jointly zero. In overall, the CAPM does
explain the return variations in portfolios formed based on past returns.

In conclusion, based on the results in three groups of portfolios; The Fama French 25
size-BE/ME portfolios, the LSV portfolios, and the Past returns portfolio, it can be
seen that the return variations are explained by the simple CAPM. Even though there
are some exceptions in the small value portfolios, all the GRS test accept the null
hypothesis of jointly zero-alphas. In the next sub-section, this study performs time-
series regressions with the Fama French three-factor model that is argued to be able to
better capture the variation in small value portfolios.

2. Fama French Three-Factor Model
a. 25 Fama French Size-BE/ME Portfolios
In order to test whether the Fama French three-factor model is able to explain
variation in portfolio formed based on size and BE/ME especially the small value
portfolios, the 25 size-BE/ME portfolios are regressed using the Fama French three-
factor model. Table XI shows the results of time series regressions on Fama French 25
size-BE/ME portfolios using the three-factor model. As can be seen on Table XI, most
of the regression intercepts are statistically not different from zero. However, the
estimated intercepts among the small value (small size and high BE/ME) portfolios
are statistically significant, as evidenced by the t(a) values in the upper right corner of
Table XI. The results show that three-factor model also cannot capture the returns
variation in the small value portfolios. The estimated intercepts suggest that the model
leaves a negative unexplained return for the portfolio of stocks in the high BE/ME
quintile.

59

The F-test of Gibbons, Ross, and Shanken (GRS 1989) accepts the hypothesis that
Fama French three-factor model can explain all the variations in the average monthly
returns on the 25 size-BE/ME portfolios at any significance level. The average of the
25 regression R
2
is 0.63. The model does explain 63 percent of the variation in the
average returns on the portfolios. Comparing the results in Table XI with those in
Table X, Fama French three-factor model only performs slightly better than the
simple CAPM. The Three-factor model explains the variation of 25 size-BE/ME
portfolios by 2 percent better than CAPM. The returns variation in the small value
portfolios are still left unexplained.

Looking at the coefficients, the pattern suggests that high BE/ME stocks have higher
slope on HML than low BE/ME stocks. Small stocks tend to have higher slopes on
SMB. Controlling for size, high BE/ME stocks have smaller values on SMB
coefficients than those of low BE/ME stocks. The finding seems to suggest that high
BE/ME stocks comprise of small stocks.

In overall, utilizing the Fama French three-factor model in explaining the return
variations in the 25 size-BE/ME portfolios does not add much improvement to the
results. Both models cannot explain the returns variations in the small value
portfolios, even though based on the GRS test, the alphas are jointly zero. The slope
on both HML and SMB shows that high BE/ME stocks and small stocks have higher
return, as evidenced by higher positive value in their factor loading.

b. LSV Portfolios
Following Lakonishok et al. (1994), time-series regressions are performed on the
returns of portfolios formed on the basis of the rank of BE/ME, CF/P, and E/P. In
order to maintain a respectable number of sample stocks in each portfolio, stocks are
allocated into quintiles. To be included in the tests for a given year, a stock must have
data on all off the characteristics used to form the portfolios. Thus, the sample firms
are the same for all variables. The sample period uses for BE/ME and E/P portfolios
are from December 1991 to December 2008, resulting in 205 monthly observations.
However, due to data availability, the sample period for CF/P portfolios begins on

60

December 1991 and ends on December 2007, resulting in a time series of 193
monthly returns.

Table XII shows the results of time series regressions using Fama French three-factor
model. The estimates of the three-factor regression in Table XII show that the three-
factor model can capture most the variation in average returns. The average of the R
2

for portfolios based on BE/ME, E/P, and CF/P are 0.91, 0.89, and 0.92 respectively.
As evidenced before by the results of the CAPM regressions on LSV portfolios, the
estimated intercepts using the three-factor model in portfolios based on BE/ME are
also statistically insignificant except for portfolios with the highest BE/ME. The Fama
French three-factor model also perform well in explaining the return variations in
portfolios based on CF/P, specifically all intercepts are statistically not different from
zero. The exception is again for portfolios based on E/P which almost all estimated
intercepts are statistically different from zero. The GRS test accepts the hypothesis
that the regression intercepts for a set of five portfolios are all 0.0. The p-value of
GRS tests are 0.057, 0.31, and 0.99 for portfolios based on BE/ME, E/P, and CF/P
respectively. In term of the magnitude of the GRS tests, the three-factor model does a
better job for the 25 Fama French size-BE/ME portfolios than it does on the LSV
portfolios.

Based on the results in Table XII, higher BE/ME and E/P portfolios have larger slopes
on HML. As has been observed by Fama and French (1995) and confirmed by the
results of portfolio zero in previous section, loadings on HML are a proxy for relative
distress. Consequently, these findings infer that low BE/ME and E/P are typical of
strong stocks, while high BE/ME and E/P are typical of stocks that are relatively
distressed. The slopes on SMB, however, show no clear pattern for both BE/ME and
E/P portfolios. Among the three LSV portfolios in Table XII, only the CF/P-rank
portfolios show no exact relations between average returns and HML. In CF/P
portfolios, SMB slopes seem to suggest that higher CF/P portfolios produce higher
slopes than those of lower CF/P portfolios. This pattern indirectly implies that high
CF/P portfolios consist of smaller stocks than low CF/P portfolios.


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In short, utilizing the Fama French three-factor model in explaining the return
variations in the LSV portfolios does not make any significant different to the results
of the CAPM. Both models cannot explain the returns variations in the small value
portfolios, even though based on the GRS test, the alphas are jointly zero. However,
the use of the Fama French three-factor model can add insight to stocks performance
in each portfolio. For instance, from the slope on SMB, we can observe that high
CF/P stocks consist of small stocks.

c. Portfolios based on Past Returns
DeBondt and Thaler (1985) argue that in long-term period (three to five years), stocks
experience a reversal (contrarian) pattern. Specifically, winners (stocks with high past
returns) have lower future returns than losers (stocks with low past returns). Jegadeesh
and Titman (1993), however, observe a continuation (momentum) pattern in the
medium-term. According to momentum pattern, when portfolios are formed based on
intermediate-term (three to 12 months) past returns, past losers continue to be future
losers and past winners are still the future winners.

Table XIII below shows the results of the Fama French three-factor regressions on
monthly excess returns of portfolios formed based on 12 to 2 average
monthly returns. In total, there are 182 monthly obervations. In order to reduce bid-
ask bounce bias, one month is skipped on the portfolio formation month before
ranking the stocks at month .

The GRS test in Table XIII confirms that the Fama French three-factor model is able
to explain the variation in the future returns on portfolios formed based on past
returns. The null hypothesis that all intercepts are jointly zero is accepted at any
significane level. The results, however, contradict the common belief that in medium-
term, stocks exhibit momentum pattern. Based on Table XIII, medium-term past
losers have higher risk loading on HML. Higher slopes on HML for past losers imply
that they behave like distressed stocks. Thus, the model predicts that medium-term
past losers will have higher average returns in the future than those of past winners.

62

In short, contrary to Jegadeesh and Titman (1993), Indonesian stock market exhibits
reversal patterns in medium-term period. The fact that past losers have higher loading
on HML than past winners, might be the reason of past-losers outperformance. Based
on the results examined in Table XIII, this study argues that losers tend to consist of
stocks with high BE/ME (proxy of relative distressed), and therefore outperform
winners.

3. The Post-Crisis Analysis of the Value Premium
The majority of past studies investigating the existence of value premium in Asian
markets, especially Indonesian stock market, rely on data that ends prior to the year
2000 or even before the onslaught of Asian financial crisis of 1997-1998. In addition,
Brown, Rhee and Zhang (2008) argue that value premium is time-varying. Therefore,
in order to explore whether the behavior of value premium in Indonesian stock market
varies within the sample period and to confirm the robustness of my findings, the
results from section IV are examined and compared with the results of the post-crisis
period.

According to IMF January 1999 Factsheet The IMFs Response to the Asian Crisis,
Indonesia is regarded as one of the most affected countries during the Asian financial
crisis. The evidence shows that Asian crisis has a considerable impact to Indonesia
stock market, as showed by Liou (2002), between June 1997 and December 1997
alone, the stock market index in Indonesia has declined by 44.6 percent. Since the
sample period in this study includes the year when the Asian financial crisis occurred,
specifically the severe period from July 1997 to July 1998, the same procedures for
value premium are performed using only the post-crisis sample period.

Table XIV, Panel A provides the evidence for equal-weighted returns in the post-
crisis sample period. Interestingly, the post-crisis equal-weighted average returns for
all the portfolios formed based on three value characteristics are higher than those in
the whole period. The results summarized in Table XIV are similar to those in the

63

whole period. Value stocks outperform growth stocks and a 1-year buy and hold value
stocks strategy produces the highest average return.

Panel B summarizes the results of the same strategies using value-weighted average
returns. Despite of two-year negative value premium for CF/P-based portfolios, the
post-crisis results have only slight differences from the whole period results. Similar
to the one in Table III, CF/P-based portfolios have on average a negative value
premium. Overall, the evidence seems to suggest that the behavior of value premium
in Indonesia stock market does not change after the Asian financial crisis.

4. Jegadeesh and Titman Methodology of Momentum and
Contrarian Strategy
In order to ascertain the robustness of momentum/contrarian profits found in previous
section, some analysis are performed using an adaptation of Jegadeesh and Titman
(1993) approach. The procedures are as follows: Firstly, JKSE stocks are sorted into
three groups (High, Medium and Low trading volume) based on their lagged trading
volume. Then, following Jegadeesh and Titman (1993), in each volume group, at the
beginning of each month , JKSE stocks are ranked on ascending order based on their
performance during the formation period, from time to 1. Based on these
rankings, three portfolios are formed that equally weight the stocks contained in each
group of stock. The first group is called the loser, whereas the last group is called
the winner. Therefore, the return of winner portfolio is the average holding period
returns of stocks in the highest 30 percent ranks, whereas the return of loser portfolio
is the average holding period returns of all stocks within the lowest 30 percent ranks.
In each month , the strategy buys the winner portfolio and sells the loser portfolio,
holds the position for E months. Therefore in each F/H strategy, there are six
individual portfolios (Winner-High, Winner-Medium, Winner-Low, Loser-High,
Loser-Medium, and Loser-Low) and three zero-cost portfolios (Winner minus Loser-
High, Winner minus Loser-Medium, and Winner minus Loser-Low). As before, for
simplicity, only strategy that selects stocks on the basis of returns over the past F
formation periods and holds them for the same H holding periods is performed. In

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specific, different strategies with the same combination of F and H periods are
employed. Finally, the portfolios are rebalanced monthly and the average monthly
returns during the holding period of each strategy are calculated.

Jegadeesh and Titman methodology provides similar evidences to Lo and MacKinlay
methodology. As can be seen in Table XV, independently, winner and loser in both
1/1 and 12/12 strategies have positive average returns.

The result of 1/1 strategy is not consistent with that predicted by Hameed and Ting
(2000) that loser stocks tend to have higher average returns in high volume group. The
evidence from table XV show the exact opposite of what was predicted. As we move
to the higher volume group, the average returns of losers decrease and the average
returns of winners increase. Using the reasoning of Lakonishok et al. (1994) in
analysing winner stocks performance based on one month past returns, we can argue
that in short-term, investors tend to be overly optimistic about winner with high
lagged trading volume. Consequently, the winner in high volume group is able to
continue its last month performance in the next month. In low volume group, on the
other hand, infrequently traded past one-month loser outperforms infrequently traded
past one-month winner. The highest possible average monthly returns (4.11 percent)
on the zero-cost strategy can be earned by buying past one-month loser with low
lagged volume and hold it for one-month. The results in 12/12 strategy are similar
with those in 1/1 strategy, the pattern however, is not clear enough to draw an exact
conclusion.

Overall, the results of winner loser are mostly negative and statistically significant
across portfolios and strategies as summarized in fourth column of Table XV. Similar
to the results using Lo and MacKinlay methodology, zero-cost strategies using
Jegadeesh and Titman methodology also favor contrarian strategy.


65

5. The post-crisis analysis of Jegadesh and Titman methodology
for momentum versus contrarian strategies
In order to confirm the robustness of the findings of this study, the subperiod
performance of momentum/contrarian strategy is also examined. The sample period
is divided into two subperiods: (i) before crisis, from December 1991 to June 1997
and (ii) after crisis, from August 1998 to December 2008. The results in both
subperiod as summarized in Table XVI, suggesting a similar conclusion to those in
the whole period. Loser and winner stocks in both subperiod exhibit momentum
patterns across all strategies and portfolios. Loser stocks that are classified in the low
volume group, have higher momentum average returns than those that are assigned to
high volume group. Zero-cost strategies in both subperiods produce negative average
returns across portfolios. The exception are those stocks in high volume group in 1/1
zero-cost strategy, which on average have statistically insignificant positive returns.

In short, the performance of momentum/contrarian returns in Indonesia stock market
within the sample period are not time-varying. In addition, as can be seen on Table
XVII, the same strategy and methodology is applied to the whole period, excluding
the crisis period, generates similar results.


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VI. Conclusion
This study examines (i) whether the value premium, the size effect and
momentum/contrarian return exist in Indonesia stock market and how to exploit such
profitable strategy if they do exist, (ii) whether the Fama French three-factor model
outperforms the CAPM, and (iii) whether differentiate stocks based on trading volume
results in different performance.

The results in this study can be summarized into four propositions. Firstly, as can be
seen from Table III and IV, a variety of investment strategies that utilize an annual
buy and hold strategy of value stocks have outperformed those of glamour stocks over
the period ranging from December 1991 to December 2008. Secondly, based on the
results presented in Table VI and VII, in medium-term, Indonesian stock market
exhibits reversal pattern. Based on the evidence, a likely reason of this reversal
behavior is the fact that Indonesian investors overreaction toward losers is higher
than their overreaction toward winners. Consequently, since the reversal effect in
losers is more significant than the overvaluation effect in winners, losers outperform
winners. Thirdly, as showed in Table VII, this research discovered no difference in
stocks behavior within various volume groups. All volume groups display reversal
pattern and the magnitude increases as the lagged volume decreases. Fourthly, the
evidences in Table XI-XIII show that the Fama French three-factor model does only
slighty better job in explaining variation in stock returns than the CAPM with the
returns variation in the small value portfolios still left unexplained. However, despite
some statistically significant intercepts, the results of the GRS tests accept the null
hypothesis that alphas are jointly zero. By regressing three-factor model in portfolio
based on past returns, this study discovered that another explanation of losers
outperformance is the fact that losers have higher loading on HML than winners.
Based on the evidence in Table XIII, it seems that losers tend to consist of stocks with
high BE/ME (value stocks) and winners consist of low BE/ME stocks (growth
stocks).


67

Another important result is that most investors can generate profit by performing 1-
year buy and hold strategy of value stocks. Looking deeper into investment strategies,
this study found that Indonesian investors seem to undervalue stocks with low past
growth, however are attracted to stocks with high expected earnings performance.
Therefore, as showed in Table IV, high average return can be obtained by buying and
holding stocks which have lowest past growth as proxies by BE/ME and highest
expected growth rates as proxies by E/P.

The robustness tests confirm the existence of value premium and profitable contrarian
strategies in Indonesian stock market both before and after the crisis period. Using
Jegadeesh and Titman methodology in analysing momentum versus contrarian
strategies, as shown in Table XV, this study provides that in short-term (one month),
investors tend to overly optimistic about winner with high lagged volume, drive its
price up and overestimate its future performance relative to loser. As a consequence,
the F/H; 1/1 strategy exhibit momentum behavior.

Based on these results, this study concludes that the value premium, the size effect
and the contrarian return exist in Indonesian stock market. However, the
implementation should be done with caution since this study does not incorporate
transaction cost in its analysis. It also should be noted that value stocks do not provide
the best performance in every observation. Moreover, the time-series regressions
performed in this study only employs constant beta. More advance tests which utilize
time-varying beta, structural breaks in stock markets, etc might be an option to
increase the validity of the test.


68

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76

Text Figures

Figure 1
The Risk Return Tradeoff

Source: Fama and French (2004)

c
b

o
o()
E(R)
Mean-variance
efficient frontier
with a riskless
asset
Minimum variance frontier
for risky assets
]

77

Figure 2
Jakarta Composite Index and Capital Market Milestones
1984-June 2008

Source: Indonesia Stock Exchange

30-Nov-2007
Consolidation of the SSX into
JSX to become IDX
2,688.332
9-Sept-2002
T+4 to T+3Settlement
430.271
28-Mar-2002
Remote Trading
481.775
6-Oct-2004
Launching
Of Stock
Option
856.060
21-Jul-2000
Scripless
Trading
512.617
23-Dec-1997
Founding
of KPEI
397.031
1-May-1995
JATS
415.322
24-Jul-1995
Merging Process of JSX into
Bursa Paralel Indonesia
509.532
23-Jul-1997
Financial Crisis
718.189
13-Jul-1992
Privatization of JSX
321.544
16-Jun-1989
Establishment of SSX
293.548
8-Aug-1996
Founding of KSEI
548.181
83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
3,000

2,500

2,000

1,500

1,000

500


78

Text Tables

Table I
The Complete Overview of all Variables
Variables Measured by Explanation
BE/ME Book-to-Market
The book value of equity for the fiscal year ending in calendar year
t-1
divided by market equity at the end of portfolio formation month

E/P Earnings to Price
The earnings before extraordinary items but after interest,
depreciation,
Earning Yield taxes, and preferred dividends for the fiscal year ending in
calendar year t-1, divided by market equity at the end of portfolio
formation month.

CF/P Cash Flow to Price
The cash flow (Earnings plus depreciation) for the fiscal year ending
in
Cash Flow Yield calendar year t-1, divided by market equity at the end of portfolio
formation month

D/P Dividends to Price The dividend per share divided by stock price
Dividend Yield

ME Market Equity Stock price times number of shares outstanding
Market Capitalization

Trading Volume Volume Turnover Number of shares traded divided by number of shares outstanding
Lagged Trading
Volume
Lagged Volume
Turnover Trading volume during the formation period

P/B Price to Book value Stock price divided by book value of equity per share
The inverse of BE/ME

P/E Price to Earnings The inverse of E/P

P/D Price to Dividends The inverse of D/P


79

Table II
Trading Value on Indonesian Stock Market
Year 2002 2003 2004 2005 2006 2007 Q1-2008
TRADING (IDR Billion)
Total Trading Value of Shares 120,763 125,438 247,007 406,006 445,708 1,050,154 317,446
Foreign Transaction of Shares 13,607 40,133 110,762 157,019 140,506 243,803 78,484
Foreign percentage (%) 11.27 31.99 44.84 38.67 31.52 23.22 24.72
Local Transaction of Shares 107,157 85,305 136,245 248,987 305,202 806,351 238,962
Source: Indonesia Stock Exchange

ote: For all tables, the comprehensive procedures in forming the portfolios are
provided in section III.
Table III
Returns for Quintiles Portfolios Based on One-Dimensional Classification by
Various Measures of Value Characteristics
The returns presented in the table are averages over all formation periods. R
t
is the average return in
year after formation, = 1, ,S. For example: at the end of December 1991, JKSE stocks are ranked
in ascending order into quintiles based on BE/ME, CF/P, and E/P. The R
1
are calculated from January
1992 to December 1992. AR is the average annual return over 5 post formation years. The portfolios
are rebalanced annually. Glamour portfolios refer to portfolios that contain stocks with lowest rank on
BE/ME, CF/P, and E/P. Value portfolios refer to portfolios of stocks with highest rank on BE/ME,
CF/P, and E/P. Portfolios 0 refer to stocks with negative values on those value characteristics. Panel
A2, B2, and C2 provide the value-weighted returns.
Glamour Value
0 1 2 3 4 5
Panel A1: Rank Based on BE/ME
R
1
0,0320 -0,0011 0,0056 0,0132 0,0241 0,0491
R
2
0,0315 0,0048 0,0105 0,0145 0,0255 0,0458
R
3
0,0348 0,0077 0,0106 0,0158 0,0250 0,0381
R
4
0,0356 0,0091 0,0137 0,0167 0,0235 0,0367
R
5
0,0347 0,0127 0,0160 0,0179 0,0254 0,0368
AR 0,0337 0,0066 0,0113 0,0156 0,0247 0,0413

Panel B1: Rank Based on CF/P
R
1
0,0160 0,0279 0,0209 0,0226 0,0117 0,0101
R
2
0,0207 0,0170 0,0207 0,0193 0,0192 0,0298
R
3
0,0250 0,0155 0,0190 0,0185 0,0220 0,0282
R
4
0,0245 0,0159 0,0137 0,0145 0,0219 0,0231
R
5
0,0267 0,0209 0,0134 0,0149 0,0219 0,0283
AR 0,0226 0,0194 0,0175 0,0180 0,0193 0,0239

80

Glamour Value
0 1 2 3 4 5
Panel C1: Rank Based on E/P
R
1
0,0389 0,0058 0,0066 0,0122 0,0213 0,0388
R
2
0,0168 0,0129 0,0122 0,0155 0,0232 0,0356
R
3
0,0137 0,0147 0,0130 0,0164 0,0208 0,0329
R
4
0,0156 0,0155 0,0157 0,0167 0,0202 0,0323
R
5
0,0192 0,0170 0,0179 0,0183 0,0214 0,0314
AR 0,0208 0,0132 0,0131 0,0158 0,0214 0,0342

Panel A2: Rank Based on BE/ME-Value Weighted
R
1
0,0131 0,0005 0,0004 0,0006 0,0014 0,0019
R
2
0,0037 0,0004 0,0006 0,0005 0,0013 0,0014
R
3
0,0059 0,0004 0,0005 0,0005 0,0010 0,0010
R
4
0,0074 0,0004 0,0006 0,0005 0,0010 0,0010
R
5
0,0072 0,0005 0,0007 0,0006 0,0010 0,0011
AR 0,0075 0,0004 0,0006 0,0005 0,0011 0,0013
Panel B2: Rank Based on CF/P-Value Weighted
R
1
-0,0003 0,0012 0,0008 0,0008 0,0004 -0,0003
R
2
-0,0003 0,0008 0,0005 0,0008 0,0008 0,0005
R
3
0,0000 0,0005 0,0005 0,0006 0,0007 0,0005
R
4
0,0007 0,0005 0,0004 0,0004 0,0006 0,0005
R
5
0,0011 0,0006 0,0004 0,0005 0,0007 0,0007
AR 0,0002 0,0007 0,0005 0,0006 0,0007 0,0004

Panel C2: Rank Based on E/P-Value Weighted
R
1
0,0229 0,0005 0,0005 0,0006 0,0011 0,0015
R
2
0,0127 0,0004 0,0004 0,0006 0,0010 0,0013
R
3
0,0123 0,0004 0,0005 0,0005 0,0008 0,0012
R
4
0,0126 0,0004 0,0005 0,0006 0,0008 0,0011
R
5
0,0121 0,0005 0,0005 0,0007 0,0008 0,0010
AR 0,0145 0,0004 0,0005 0,0006 0,0009 0,0012

Table IV
Returns for Portfolios Based on Two-Dimensional Classifications by Various
Measures of Value Characteristics
t
year after formation, = 1, ,S. For example: at the end of December 1991, JKSE stocks are
classified into 9 groups based on the intersection of BE/ME and CF/P. The R
1
are calculated from
January 1992 to December 1992 for each of the portfolios in the 9 groups of stocks. AR is the average
annual return over 5 post formation years. The portfolios are rebalanced annually. Glamour portfolios
refer to portfolios that contain stocks with lowest rank on both value characteristics. Whereas value
portfolios refer to portfolios of stocks with highest rank on two value characteristics. Panel A2 and B2
provide the value-weighted returns.

81

Panel A1: BE/ME and E/P Equal-Weighted
Glamour Value
BE/ME 1 1 1 2 2 2 3 3 3
E/P 1 2 3 1 2 3 1 2 3
R1 0,0002 0,0011 0,0095 0,0023 0,0119 0,0229 0,0367 0,0299 0,0420
R2 0,0103 0,0049 0,0246 0,0173 0,0140 0,0230 0,0178 0,0284 0,0379
R3 0,0127 0,0088 0,0127 0,0169 0,0144 0,0176 0,0271 0,0279 0,0199
R4 0,0185 0,0141 0,0151 0,0286 0,0156 0,0194 0,0331 0,0164 0,0229
R5 0,0243 0,0251 0,0375 0,0171 0,0186 0,0228 0,0724 0,0338 0,0293
AR 0,0132 0,0108 0,0199 0,0164 0,0149 0,0211 0,0374 0,0273 0,0304
Panel B1: BE/ME and CF/P Equal-Weighted
Glamour Value
BE/ME 1 1 1 2 2 2 3 3 3
CF/P 1 2 3 1 2 3 1 2 3
R1 0,0094 0,0010 -0,0211 0,0258 0,0202 -0,0041 0,0675 0,0459 0,0287
R2 -0,0001 0,0031 0,0341 0,0080 0,0134 0,0282 0,0428 0,0244 0,0386
R3 0,0087 0,0095 0,0097 0,0130 0,0141 0,0278 0,0391 0,0137 0,0248
R4 0,0164 0,0099 0,0182 0,0214 0,0181 0,0254 0,0244 0,0192 0,0303
R5 0,0226 0,0295 0,0250 0,0320 0,0150 0,0211 0,0272 0,0402 0,0257
AR 0,0114 0,0106 0,0132 0,0200 0,0162 0,0197 0,0402 0,0287 0,0296
Panel A2: BE/ME and E/P Value-Weighted
Glamour Value
BE/ME 1 1 1 2 2 2 3 3 3
E/P 1 2 3 1 2 3 1 2 3
R1 0,0005 0,0011 0,0027 0,0012 0,0008 0,0031 0,0089 0,0048 0,0029
R2 0,0006 0,0003 0,0242 0,0012 0,0011 0,0045 0,0030 0,0020 0,0025
R3 0,0008 0,0001 -0,0077 0,0006 0,0007 0,0009 0,0048 0,0022 0,0005
R4 0,0009 0,0019 0,0057 0,0036 0,0008 0,0024 0,0104 0,0008 0,0009
R5 0,0011 0,0028 0,0243 0,0018 0,0014 0,0025 0,0550 0,0043 0,0016
AR 0,0008 0,0013 0,0098 0,0017 0,0010 0,0027 0,0164 0,0028 0,0017
Panel B2: BE/ME AND CF/P Value-Weighted
Glamour Value
BE/ME 1 1 1 2 2 2 3 3 3
CF/P 1 2 3 1 2 3 1 2 3
R1 0,0013 0,0012 -0,0211 0,0071 0,0011 -0,0003 0,0116 0,0054 0,0019
R2 0,0005 0,0008 0,0341 0,0039 0,0008 0,0020 0,0069 0,0022 0,0023
R3 0,0003 0,0007 0,0097 0,0007 0,0004 0,0008 0,0040 -0,0017 0,0006
R4 0,0010 -0,0010 0,0182 -0,0057 0,0006 0,0049 0,0019 0,0004 0,0013
R5 0,0007 0,0027 0,0250 0,0122 0,0010 0,0014 0,0051 0,0046 0,0015
AR 0,0008 0,0009 0,0132 0,0036 0,0008 0,0018 0,0059 0,0022 0,0015


82

Table V
Returns for Portfolios Based on Size-Classifications
t
in ascending order into quintiles based on their ME. The R
1
are calculated from January 1992 to
December 1992. AR is the average annual return over 5 post formation years. The portfolios are
rebalanced annually. Big portfolios refer to portfolios that contain stocks with highest rank on ME.
Small portfolios refer to portfolios of stocks with lowest rank on ME. Panel B provides the value-
weighted returns.
Panel A: Rank Based on Size
Big Small
1 2 3 4 5
R1 0,0160 0,0151 0,0167 0,0174 0,0255
R2 0,0157 0,0154 0,0197 0,0226 0,0328
R3 0,0143 0,0126 0,0179 0,0237 0,0309
R4 0,0141 0,0134 0,0183 0,0250 0,0304
R5 0,0144 0,0153 0,0201 0,0265 0,0303
AR 0,0149 0,0144 0,0185 0,0231 0,0300
Panel B: Rank Based on Size-Value Weighted
Big Small
1 2 3 4 5
R1 0,0004 0,0003 0,0003 0,0004 0,0006
R2 0,0004 0,0004 0,0004 0,0005 0,0007
R3 0,0004 0,0003 0,0004 0,0006 0,0006
R4 0,0004 0,0003 0,0004 0,0006 0,0007
R5 0,0004 0,0004 0,0004 0,0007 0,0007
AR 0,0004 0,0003 0,0004 0,0005 0,0007

Table VI
An Overlapping Momentum/Contrarian Average Monthly Returns of JKSE
Stocks: 12/1991-12/2008 using Lo and MacKinlay (1990) Methodology
At the beginning of each month, all stocks are ranked based on their past performance during formation
period (F). The stocks that outperform the market are assigned to Winner portfolio, those that
underperform the market to the Loser portfolio. The portfolios return are value weighted depends on
their past performance and held for holding (H) period months. The table gives the average monthly
returns for both winner and loser portfolios for the period 1991 to 2008. In addition, the returns of zero-
cost strategies which buy winner and sell loser are also presented. t-stat is the average return divided by
its standard error.


83

F/H Total Winner Loser
1/1 Average Returns -0,14% 0,09% -0,23%
t-stat -1,41 0,41 -1,39
3/3 Average Returns -0,06% 0,07% -0,13%
t-stat -2,60 2,49 -3,89
6/6 Average Returns -0,01% 0,07% -0,08%
t-stat -1,52 4,12 -5,75
12/12 Average Returns -0,04% 0,03% -0,06%
t-stat -4,99 3,97 -5,75

Table VII
Momentum/ Contrarian Average Returns using Lo and MacKinlay (1990)
Methodology that incorporates Trading Volume
At the beginning of each month, stocks are divided into three groups based on their lagged trading
volume. Within each volume group, all stocks are ranked based on their formation period (F)
performance. The stocks that outperform the market are assigned to Winner portfolio, those that
underperform the market to the Loser portfolio. The portfolios return are value weighted depends on
their past performance and held for H months. The table gives the average monthly returns for both
winner and loser portfolios for the period 1991 to 2008. In addition, the returns of zero-cost strategies
which buy winner and sell loser are also presented. t-stat is the average return divided by its standard
error.
F/H Volume Turnover Total Winner Loser
1/1 High AR 0,11% 0,35% -0,24%
t-stat 0,80 2,35 -1,94
Medium AR -0,21% 0,19% -0,40%
t-stat -2,77 1,52 -2,99
Low AR -0,17% 0,12% -0,29%
t-stat -1,37 0,54 -2,03
12/12 High AR -0,02% 0,03% -0,05%
t-stat -2,55 3,34 -3,96
Medium AR -0,04% 0,02% -0,06%
t-stat -4,99 3,03 -5,06
Low AR -0,03% 0,03% -0,06%
t-stat -5,55 7,06 -7,74

84

Table VIII
The CAPM Time-Series Regressions for Monthly Excess Returns on 25
Portfolios Formed on Size and BE/ME: 12/1991-12/2008, 205 Months
GRS is the F-statistic of Gibbons, Ross, and Shanken (1989), testing the hypothesis that the regression
intercepts for a set of five portfolios are all 0,0. p(GRS) is the p-value of GRS, that is the probability of
a GRS value as large or larger than the observed value if the zero-intercepts hypothesis is true. t( )
refers to t-statistics, the average return divided by its standard error. s(e) refers to standar error of the
regressions.

Regressions:
t
]
= o + |
Mt

]
][
M
+ e
t

Book-to-Market Equity (BE/ME) Quintiles
Size Low 2 3 4 High Size Low 2 3 4 High
a t(a)
Small -0,01 -0,03 -0,02 -0,03 -0,02 Small -0,78 -1,98 -1,01 -3,22 -3,40
2 0,01 -0,01 -0,01 -0,01 -0,03 2 0,36 -0,71 -0,69 -1,60 -3,82
3 0,02 -0,01 0,01 0,07 -0,02 3 1,32 -1,29 1,19 3,06 -2,29
4 0,02 -0,01 0,01 0,00 0,00 4 2,15 -0,90 1,80 -0,15 0,35
Big -0,01 0,00 -0,01 -0,01 -0,03 Big -0,95 0,07 -0,99 -1,75 -0,72

GRS = 1, 59, p-value = 0,99

b

t(b)
Small 0,85 0,73 0,62 0,88 1,03

Small 14,54 9,76 5,40 21,58 28,01
2 0,89 0,73 0,70 0,97 1,00

2 11,42 10,35 20,67 21,85 23,11
3 0,85 0,77 1,07 1,43 1,11

3 11,34 13,29 23,40 12,81 26,72
4 0,94 0,86 1,07 1,12 1,19

4 18,87 26,55 31,17 29,60 22,52
Big 0,79 0,90 0,84 1,04 1,19

Big 23,66 23,68 14,22 24,20 4,44

R
2
s(e)
Small 0,58 0,34 0,15 0,73 0,81 Small 0,12 0,15 0,22 1,17 0,07
2 0,43 0,38 0,70 0,72 0,73 2 0,16 0,14 0,09 0,09 0,09
3 0,40 0,50 0,74 0,47 0,80 3 0,15 0,12 0,09 0,23 0,08
4 0,68 0,79 0,83 0,83 0,76 4 0,10 0,07 0,07 0,08 0,11
Big 0,74 0,75 0,53 0,76 0,11 Big 0,07 0,08 0,12 0,09 0,47


85

Table IX
The CAPM Time-Series Regressions for Monthly excess Returns on the LSV
Equal-Weight Quintiles: 12/1991-12/2008, 205 Months
GRS and p(GRS) are defined in Table VIII. ( ) is the t-statistics, the average return divided by its
standard error.
Quintiles
1 2 3 4 5 GRS p(GRS)
BE/ME Low High
a 0,00 0,00 0,00 0,00 -0,02
b 0,83 0,86 0,95 1,08 1,08
t(a) 0,22 -0,63 -0,63 0,61 -4,31 16,52 0,005
t(b) 33,48 40,76 43,66 40,65 49,76
R
2
0,85 0,89 0,90 0,89 0,92
EP Low High
a 0,02 -0,01 -0,02 -0,02 -0,02
b 0,99 0,86 0,85 0,89 0,98
t(a) 3,41 -1,75 -5,79 -4,97 -4,28 12,65 0,027
t(b) 38,67 36,92 43,40 40,20 41,66
R
2
0,88 0,87 0,90 0,89 0,90
CFP Low High
a 0,01 0,00 0,00 -0,01 -0,01
b 1,08 0,98 0,95 0,98 1,00
t(a) 1,49 0,50 -0,52 -1,20 -1,01 0,49 0,99
t(b) 33,76 34,88 36,68 45,12 41,82
R
2
0,89 0,90 0,91 0,94 0,93


86

Table X
The CAPM Time-Series Regressions for Monthly Excess Returns on Equal-
Weight Portfolios Formed on Past Returns: 12/1992-1/2008, 182 Months
The table below shows the results of the CAPM time series regressions on monthly excess returns of
portfolios formed based on past 12 month returns. GRS and p(GRS) are defined in Table VIII. ( ) is
the t-statistics, the average return divided by its standard error.
Portfolio Formation Months t-12 to t-2
1 2 3 4 5
Low High
a 0,02 0,00 -0,01 -0,01 -0,01
b 1,14 1,00 0,98 0,98 0,92
t(a) 3,91 0,15 -1,67 -1,70 -1,52
t(b) 34,37 44,96 48,56 44,14 36,14
R
2
0,87 0,92 0,93 0,92 0,88
GRS = 1,38 , p-value = 0,93

Table XI
The Fama French Three-Factor Regressions for Monthly Excess Returns on 25
Portfolios Formed on Size and BE/ME: 12/1991-12/2008, 205 Months
standard error. s(e) refers to standard error of the regressions.

Regressions: : R
|t
R
= u + |R
t
R
]
|
+
|
SB + h
|
+s
|t

a t(a)
Small 0,00 -0,02 -0,01 -0,02 -0,02 Small 0,24 -1,63 -0,66 -2,72 -3,01
2 0,02 0,00 0,00 -0,01 -0,03 2 1,39 -0,26 -0,13 -1,68 -3,66
3 0,02 -0,02 0,01 0,05 -0,02 3 1,51 -1,38 1,18 2,63 -2,29
4 0,02 -0,01 0,01 0,00 0,00 4 2,29 -1,09 1,41 -0,61 0,00
Big -0,01 0,00 -0,02 -0,02 -0,05 Big -1,14 -0,68 -1,32 -2,36 -1,12
GRS = 0,53 , p-value = 0,99
b t(b)
Small 1,03 0,95 0,75 0,94 1,03 Small 16,13 11,88 5,55 20,31 25,18
2 1,12 0,84 0,94 0,89 0,99 2 12,83 10,45 19,37 17,73 19,87
3 1,01 0,83 1,07 1,04 1,05 3 12,05 12,42 20,07 8,84 22,18
4 1,04 0,90 1,05 1,01 1,07 4 18,45 24,29 26,93 24,84 17,84
Big 0,88 0,90 0,79 1,02 0,59 Big 24,27 21,88 11,64 21,31 1,92

87

s t(s)
Small 0,69 0,63 0,48 0,29 0,27 Small 3,71 4,05 1,88 3,26 3,40
2 0,95 0,16 0,40 -0,01 0,05 2 4,10 5,34 4,11 -0,14 0,54
3 0,27 -0,11 0,00 -0,92 0,00 3 1,67 -0,82 0,03 -4,12 0,00
4 -0,03 -0,06 -0,20 -0,33 -0,14 4 -0,27 -0,81 -2,67 -4,20 -1,18
Big 0,00 -0,36 -0,36 -0,35 -1,13 Big -0,03 -4,57 -2,68 -3,79 -1,46
h t(h)
Small -0,40 -0,55 -0,24 -0,12 0,09 Small -2,84 -4,41 -1,13 -1,57 1,43
2 -0,44 -0,21 0,05 0,26 0,05 2 -2,32 -1,63 0,67 3,29 0,60
3 -0,45 -0,23 0,00 1,04 0,21 3 -3,56 -2,28 0,05 5,61 2,85
4 -0,35 -0,16 -0,01 0,26 0,37 4 -3,86 -2,68 -0,17 4,12 3,73
Big -0,30 -0,14 0,06 -0,05 1,60 Big -5,39 -2,19 0,52 -0,69 2,66
R
2
s(e)
Small 0,67 0,16 0,17 0,75 0,82 Small 0,10 0,17 0,22 0,08 0,07
2 0,53 0,41 0,72 0,74 0,73 2 0,14 0,14 0,09 0,09 0,09
3 0,45 0,52 0,74 0,57 0,81 3 0,15 0,11 0,09 0,21 0,08
4 0,70 0,80 0,84 0,85 0,78 4 0,10 0,07 0,07 0,07 0,10
Big 0,77 0,78 0,55 0,78 0,19 Big 0,06 0,07 0,12 0,08 0,45

Table XII
The Fama French Three-Factor Regressions for Monthly excess Returns on the
LSV Equal-Weight Quintiles: 12/1991-12/2008, 205 Months
standard error.
Quintiles
1 2 3 4 5 GRS p(GRS)
BE/ME Low High
a 0,00 0,00 0,00 0,00 -0,02
b 0,95 0,91 0,95 0,97 1,05
s 0,13 -0,06 0,04 -0,22 0,09
h -0,38 -0,18 0,01 0,32 0,13
t(a) 0,47 -0,99 -0,50 0,22 -4,05 10,71 0,057
t(b) 42,09 39,88 37,94 36,95 43,94
t(s) 2,93 -1,40 0,80 -4,37 2,04
t(h) -10,97 -5,24 0,14 7,94 3,64
R
2
0,90 0,91 0,90 0,92 0,93
EP Low High
a 0,02 -0,01 -0,02 -0,02 -0,02
b 1,04 0,91 0,87 0,91 0,99
s 0,06 0,10 -0,08 -0,04 0,10
h -0,17 -0,15 -0,14 -0,08 0,02

88

Quintiles
1 2 3 4 5 GRS p(GRS)
EP Low High
t(a) 3,57 -1,56 -6,43 -5,13 -3,95 5,96 0,31
t(b) 36,76 35,42 41,10 35,94 36,62
t(s) 1,18 2,10 -2,09 -0,86 1,98
t(h) -3,99 -3,87 -4,19 -2,03 0,56
R
2
0,89 0,88 0,91 0,89 0,90
CFP Low High
a 0,01 0,00 0,00 -0,01 0,00
b 1,07 0,97 0,96 0,95 1,00
s -0,02 -0,08 -0,12 -0,04 0,15
h 0,02 0,01 -0,09 0,09 0,03
t(a) 1,35 0,22 -0,67 -1,62 -0,55 0,29 0,99
t(b) 27,73 28,67 32,26 36,86 36,46
t(s) -0,25 -1,31 -2,23 -0,94 3,14
t(h) 0,38 0,22 -2,18 2,35 0,84
R
2
0,89 0,90 0,92 0,94 0,93

Table XIII
The Fama French Three-Factor Regressions for Monthly Excess Returns on
Equal-Weight Portfolios Formed on Past Returns: 12/1992-1/2008, 182 Months
The table below shows the results of time series regressions of Fama French three-factor model on
monthly excess returns of portfolios formed based on past 12 month returns. GRS and p(GRS) are
defined in Table VIII. ( ) is the t-statistic, the average return divided by its standard error.
Portfolio Formation Months t-12 to t-2
1 2 3 4 5 GRS p(GRS)
Low High
a 0,02 0,00 -0,01 -0,01 -0,01
b 1,06 0,98 0,99 1,04 0,96
s -0,08 0,08 -0,07 0,10 -0,06
h 0,25 0,09 -0,04 -0,18 -0,16
t(a) 3,92 0,58 -1,94 -1,57 -1,88 0,39 0,99
t(b) 28,51 38,03 41,72 42,23 32,77
t(s) -0,83 1,24 -1,11 1,55 -0,83
t(h) 3,48 1,86 -0,89 -3,67 -2,82
R
2
0,88 0,92 0,93 0,92 0,88


89

Table XIV
Returns for Quintiles Portfolios Based on One-Dimensional Classification by
Various Measures of Value Characteristics Post Crisis Period
t
in ascending order based on BE/ME, CF/P, and E/P. The R
1
are calculated from January 1999 to
December 1999. AR is the average annual return over 5 post formation years. The portfolios are
rebalanced annually. Glamour portfolios refer to portfolios that contain stocks with lowest rank on
BE/ME, CF/P, and E/P. Value portfolios refer to portfolios of stocks with highest rank on BE/ME,
CF/P, and E/P. Portfolios 0 refer to stocks with negative values on those value characteristics. Panel
A2, B2, and C2 provide the value-weighted returns.
Panel A
Glamour Value
1 2 3 4 5 5-1
Rank Based on BE/ME Post Crisis
R1 0,0018 0,0098 0,0188 0,0300 0,0615 0,0597
R2 0,0060 0,0121 0,0153 0,0242 0,0479 0,0418
R3 0,0068 0,0134 0,0166 0,0229 0,0402 0,0334
R4 0,0090 0,0151 0,0175 0,0226 0,0378 0,0288
R5 0,0126 0,0171 0,0186 0,0244 0,0397 0,0271
AR 0,0072 0,0135 0,0174 0,0248 0,0454 0,0382
Rank Based on CF/P Post Crisis
R1 0,0167 0,0143 0,0157 0,0076 0,0069 -0,0098
R2 0,0158 0,0199 0,0199 0,0201 0,0340 0,0182
R3 0,0146 0,0210 0,0187 0,0246 0,0319 0,0174
R4 0,0140 0,0146 0,0143 0,0217 0,0214 0,0074
R5 0,0190 0,0120 0,0138 0,0191 0,0309 0,0119
AR 0,0160 0,0163 0,0165 0,0186 0,0250 0,0090
Rank Based on E/P Post crisis
R1 0,0086 0,0128 0,0161 0,0254 0,0447 0,0361
R2 0,0130 0,0145 0,0155 0,0216 0,0323 0,0193
R3 0,0150 0,0155 0,0160 0,0187 0,0319 0,0168
R4 0,0160 0,0169 0,0157 0,0199 0,0311 0,0151
R5 0,0190 0,0188 0,0167 0,0206 0,0318 0,0128
AR 0,0143 0,0157 0,0160 0,0212 0,0344 0,0200


90

Panel B
Glamour Value
1 2 3 4 5 5-1
Rank Based on BE/ME-Value Weighted Post Crisis
R1 0,0003 0,0004 0,0005 0,0013 0,0018 0,0015
R2 0,0002 0,0003 0,0003 0,0008 0,0011 0,0009
R3 0,0003 0,0004 0,0003 0,0007 0,0008 0,0006
R4 0,0003 0,0005 0,0004 0,0007 0,0009 0,0006
R5 0,0004 0,0005 0,0005 0,0008 0,0011 0,0008
AR 0,0003 0,0004 0,0004 0,0009 0,0011 0,0009
Rank Based on CF/P-Value Weighted Post Crisis
R1 0,0008 0,0005 0,0006 0,0006 0,0002 -0,0006
R2 0,0004 0,0003 0,0005 0,0005 0,0003 -0,0001
R3 0,0002 0,0004 0,0005 0,0005 0,0004 0,0001
R4 0,0002 0,0002 0,0003 0,0003 0,0002 0,0000
R5 0,0005 0,0002 0,0004 0,0003 0,0005 0,0001
AR 0,0004 0,0003 0,0004 0,0004 0,0003 -0,0001
Rank Based on E/P-Value Weighted Post crisis
R1 0,0004 0,0005 0,0007 0,0014 0,0015 0,0011
R2 0,0003 0,0004 0,0005 0,0010 0,0010 0,0007
R3 0,0004 0,0005 0,0005 0,0008 0,0010 0,0006
R4 0,0005 0,0006 0,0005 0,0010 0,0009 0,0005
R5 0,0006 0,0006 0,0007 0,0010 0,0010 0,0004
AR 0,0004 0,0005 0,0006 0,0010 0,0011 0,0007

Table XV
Jegadeesh and Titman (1993) Methodology of an Overlapping
Momentum/Contrarian Average Monthly Returns of JKSE Stocks: 12/1991-
12/2008
At the beginning of each month, three groups are formed based on stocks lagged trading volume.
Within each group, stocks are ranked in ascending order based on their formation period (F)
performance. Stocks in the top 30 percent rank are assigned as winner and those in the bottom 30
percent rank are assigned as loser. The portfolios returns are equal weighted and held for H months.
The table gives the average monthly returns for both winner and loser portfolios for the period 1991 to
2008, resulting in total of 205 monthly average returns. In addition, the returns of zero-cost strategies
error.


91

F/H Volume Turnover Winner-Loser Winner Loser
1/1 High AR 1,20% 2,84% 1,64%
t-stat 1,37 2,58 1,57
Medium AR -1,57% 1,61% 3,17%
t-stat -2,41 2,08 3,10
Low AR -2,99% 1,12% 4,11%
t-stat -4,09 1,38 5,20
12/12 High AR -0,79% 1,65% 2,44%
t-stat -2,57 5,56 5,48
Medium AR -1,17% 1,87% 3,05%
t-stat -3,71 6,90 6,43
Low AR -1,10% 1,88% 2,98%
t-stat -4,89 9,74 8,92
Table XVI
Momentum/Contrarian Average Monthly Returns of JKSE Stocks Sub-Period
Analysis: 12/1991-06/1997 and 08/1998-12/2008
The table gives the average monthly returns for both winner and loser portfolios for two sub-period;
before and after the crisis but excludes the crisis period. In addition, the returns of zero-cost strategies
error.
F/H
Volume
Turnover Winner-Loser Winner Loser
Before Crisis 1/1 High AR 0,05% 2,46% 2,41%
t-stat 0,07 2,58 2,18
Low AR -2,85% -0,07% 2,77%
t-stat -2,88 -0,11 2,67
After Crisis 1/1 High AR 1,46% 3,76% 2,30%
t-stat 1,12 2,28 1,56
Low AR -3,48% 1,97% 5,45%
t-stat -3,50 1,58 5,30
Before Crisis 12/12 High AR -0,32% 1,65% 1,98%
t-stat -1,17 4,10 4,74
Low AR 0,34% 1,65% 1,31%
t-stat 1,80 4,94 3,26

92

F/H
Volume
Turnover Winner-Loser Winner Loser
After Crisis 12/12 High AR -0,47% 2,31% 2,78%
t-stat -1,08 5,98 4,34
Low AR -1,85% 2,23% 4,08%
t-stat -6,04 8,36 8,92

Table XVII
Momentum/Contrarian Average Monthly Returns of JKSE Stocks: 12/1991-
12/2008 exclude Crisis Period 07/1997-07/1998
The table gives the average monthly returns for both winner and loser portfolios for the whole period
1991 to 2008, exclude the crisis period. In addition, the returns of zero-cost strategies which buy
winner and sell loser are also presented. t-stat is the average return divided by its standard error.
F/H Volume Turnover Winner-Loser Winner Loser
1/1 High AR 0,97% 3,31% 2,34%
t-stat 1,09 2,94 2,26
Medium AR -1,67% 2,12% 3,79%
t-stat -2,57 2,70 3,76
Low AR -3,26% 1,27% 4,53%
t-stat -4,44 1,48 5,90
12/12 High AR -0,43% 2,12% 2,54%
t-stat -1,35 7,11 5,43
Medium AR -1,00% 2,22% 3,22%
t-stat -3,03 8,21 6,45
Low AR -1,20% 2,06% 3,26%
t-stat -5,08 9,67 9,13

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The Evidence of the Value Premium, the Size

Effect, and Momentum versus Contrarian

in time-series regressions for each asset

need to be zero, not just some of them

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