The effect of time-varying risk on the profitability of contrarian investment strategies in a thinly traded market: a Kalman filter approach

On face value studies documenting contrarian profits challenge the efficient markets paradigm. However most of them assume that systematic risk is constant when in reality it varies (Ross, 1989) especially in emerging markets (Aggarwal et al., 1999). The study in the first instance investigates whether there are long-term contrarian profits in a thinly traded market, and whether such profits can be rationalized by time variation in risk using a Kalman Filtering approach. The results indicate that failing to incorporate time variation in risk may lead to biased conclusions and present false evidence against the Efficient Market Hypothesis.