the Hong Kong Monetary Authority (HKMA) bought approximately 5 percent of the outstanding equity in Hong Kong stocks over a two-week period in an attempt to stabilize equity prices.11 THE EMPIRICAL EVIDENCE The theoretical justifications are nice, but one might ask, is there empirical support for these effects in country and asset class returns? The answer is yes, and the evidence is very strong. Let's focus on two specific sources of predictability: value and momentum. By value, we mean buying cheap assets and shorting expensive assets. If the previous section is correct, a value strategy should work for several reasons. For example, a simple valuation model should discern differing equity risk premiums across countries and would overweight higher-risk-premium countries where valuations are relatively lower. Alternatively, investor overreaction to negative information may temporarily depress a specific country's equity market. Still another possibility is market segmentation, which results in relatively more attractive valuations in the segregated equity markets. Predictability across Global Equity Markets Using Valuation Measures Using only countries in developed global equity markets, imagine that we measure value using a very simple value metric: the book-to-price (B/P) ratio. We form a long/short portfolio of country equity indexes using the reported value of this measure, without any adjustments for accounting, discount rate, or tax effects across countries. At the beginning of each month, our long/short portfolio consists of equal-weight long positions in the one-third of countries with the highest B/P and equal-weight short positions in the third with the lowest B/P. Let us rebalance this portfolio monthly. Table 25.1 presents summary statistics on the portfolio's performance over the 22-year period from the beginning of 1980 to the end of 2001. The average annual excess return on this equity country selection portfolio is 4.9 percent, which means that on average, the cheapest third of equity countries outperforms the most expensive third of equity countries by 4.9 percent per year. In addition, volatility of 11.9 percent implies that the annual excess return on this portfolio exceeds zero in about 66 percent of years. The ratio of annual return to risk on the long-short portfolio represents the information ratio (IR) on this simple strategy without transaction costs. (We address transaction costs later.) As it turns out, this simple strategy earns an IR of 0.41, which is significantly positive from a statistical viewpoint. The probability that this IR would have been achieved by nThe HKMA purchases amounted to $9 billion compared to Hong Kong's total equity market capitalization of around $200 billion at the end of 1998. Source: HKMA Annual Report 1998.