Market timing and statistical arbitrage: Which market timing opportunities arise from equity price busts coinciding with recessions?

Even though a random walk process is from a statistical point of view notpredictable, some movements can be correlated with specific events concerningother variables. Then, predictable patterns may arise being dependent on this jointevent. There is evidence given that equity price busts being associated withrecessions continue until the economy switches from the state of recession to aneconomic pick-up. The following contribution takes into account the Swedishstock index OMX 30 and 25 preselected stocks. The out-of-sample period runsfrom September 12, 2008 – March 12, 2009, whereas on September 11, 2008 theofficial press release was issued that European economies face a recession. Thisstudy suggests a market timing opportunity resulting in a maximum statisticalarbitrage opportunity corresponding to a profit of 19% p.a. with an empiricalprobability of 50.14%. The optimal defensive strategies, however, exhibit excess returns of 15.12% p.a. above the benchmark with a marginal lower volatility as thebenchmark, respectively, 28.08% p.a. with 7.99 percent units higher volatility asthe benchmark.