A Relook and Retest of the Rainy Day Hedged Portfolio

Open Access
- Author:
- Phillips, Josephine
- Area of Honors:
- Finance
- Degree:
- Bachelor of Science
- Document Type:
- Thesis
- Thesis Supervisors:
- Stephen Lenkey, Thesis Supervisor
Brian Spangler Davis, Thesis Honors Advisor
Stefan M Lewellen, Faculty Reader - Keywords:
- Rainy Day Stocks
Alpha
Excess Returns
Rainy Day Hedged Portfolio
Finance
Portfolio Analysis
Covid-19
Recessions
Investing - Abstract:
- Gormsen and Greenwood (2017) design two portfolios to generate excess stock returns in both good and bad times. The authors create a measure of “bad times” and then sort stocks in good times and bad times on various characteristics such as profitability, market value, and the book-to-market ratio. They use these results to construct two portfolios, the “Rainy Day Hedged” and “Rainy Day Long Only” portfolios, that earn high excess returns and alphas during both good times and bad. Like all investment strategies, however, the true test is how well these strategies work out of sample. I examine this question in the context of the COVID-19 pandemic, which caused an unexpected recession and led to disconnects between firm performance and stock market performance that have rarely been seen in history (Caballero and Simsek, 2020). To examine the performance of the Gormsen and Greenwood (2017) strategies out of sample, I attempt to replicate their Rainy Day Hedged portfolio returns from 1963-2013 and then use data from the COVID-19 pandemic (2019-2020) to test their strategy out of sample. My replication produces excess returns and alphas that are even higher than the excess returns and alphas reported by Gormsen and Greenwood (2017). I then apply their methodology to the COVID-19 pandemic. I find that their strategy produces high excess returns and alphas even in a challenging out-of-sample test, suggesting that the “rainy day” strategy does indeed appear to offer investors strong performance in good times and bad.