A contrarian investment strategy for equity fund selection

Abstract

The following thesis examines the existence of contrarian profits in the Norwegian equity fund market. Three different pricing models are used to determine if a contrarian strategy is able to create abnormal returns in the Norwegian equity fund market from 1995-20141 . Firstly, we apply a similar approach as De Bondt and Thaler (1985) by using a single-index CAPM model. Our results initially support the work of De Bondt and Thaler, as we find significant reversals in fund returns with a two-year ranking and two-year holding strategy. Secondly, we expand the CAPM model by adding size- and value risk factors as suggested by Fama and French (1993), which results in a statistically insignificant alpha, suggesting that the strategy significantly loads on size and value. Finally, we extend the model even further, by adding Carhart's momentum factor, which also yields an insignificant alpha. Our research suggests that the single-index CAPM model, initially tested by De Bondt and Thaler, is an inferior model compared to the three-factor model introduced by Fama and French. The results indicate that contrarian investors do not obtain abnormal returns as they are simply compensated for the inherent risk of their portfolios, mainly suggested by the size effect literature by Banz (1981).