My client wanted to assess the performance of a trading strategy relying on the Altman Z-score.
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.
I designed and tested the following core hypothesis:
Firms with positive Z-scores tend to significantly outperform firms with negative Z-scores.
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 (FTSE All Share).
The firm fundamentals were matched with the stock price dataset to then retrospectively construct ex-ante portfolios each quarter.
I found statistically and economically significant evidence of positive Z-score portfolios significantly outperforming negative Z-score portfolios.