The brief
My client wanted to assess the performance of a trading strategy relying on the Altman Z-score (a publicly available metric for ‘predicting bankruptcy’).
This relies on the notion that positive Z-score firms should theoretically outperform negative Z-score firms since they’re stronger financially.
Specifically, the strategy entails rebalancing portfolios each quarter, based on the the Z-scores available as at that quarter, which in turn is based on the most recent financial statements available at the time.
The hypothesis
I designed and tested the following core hypothesis:
Firms with positive Z-scores tend to significantly outperform firms with negative Z-scores.
The datasets
The sample consists of UK publicly listed firms from December 2012 to October 2018. A 6 month lookback means the first portfolio is constructed in June 2013.
I worked with 3 separate datasets, including firm fundamentals, stock prices, and the overall market portfolio (proxied by using the FTSE All Share).
The firm fundamentals were matched with the stock price dataset to then retrospectively construct ex-ante portfolios each quarter.
The results
I found statistically and economically significant evidence of positive Z-score portfolios significantly outperforming negative Z-score portfolios.
Cumulative portfolio performance (June 2013 – October 2018)
Portfolio composition (June 2013 – October 2018)
