New strategies:
#197 – Default Risk Filter Applied on Momentum Effect within Stocks
Period of rebalancing: Monthly
Markets traded: equities
Instruments used for trading: stocks
Complexity: Complex strategy
Bactest period: 1960 – 2009
Indicative performance: 25.78%
Estimated volatility: 22.28%
Source paper:
Mahajan, Petkevich, Petkova: Momentum and Aggregate Default Risk
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2054707
Abstract:
In this paper, we explain momentum profits using innovations in aggregate economy-wide default risk. First, we show that momentum returns are positive only during high default shocks and nonexistent otherwise. Second, we present evidence suggesting that a conditional default shock factor is priced in the cross-section and can explain a large portion of the total momentum returns. According to our results, winners have potentially higher risk than losers during periods of high default shocks. We confirm this finding in alternate sub-periods where momentum is generally not observed and as well as in international data. We also provide an explanation for this finding by linking momentum profits to potential shareholder recovery during financial distress. We find that winners tend to have relatively higher risk in worsening aggregate default conditions due to lower shareholder bargaining power. These results indicate that momentum profits contain a systematic component related to aggregate default and can be explained in a rational framework.
#198 – Exploiting Term Structure of VIX Futures
Period of rebalancing: Daily
Markets traded: equities
Instruments used for trading: futures
Complexity: Complex strategy
Bactest period: 2007 – 2011
Indicative performance: 19.67%
Estimated volatility: not stated
Source paper:
Simon, Campasano: The VIX Futures Basis: Evidence and Trading Strategies
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2094510
Abstract:
This study demonstrates that the VIX futures basis does not have significant forecast power for the change in the VIX spot index from 2006 through 2011 but does have forecast power for subsequent VIX futures returns. The study then demonstrates the profitability of shorting VIX futures contracts when the basis is in contango and buying VIX futures contracts when the basis is in backwardation with the market exposure of these positions hedged with mini-S&P 500 futures positions. The results indicate that these trading strategies are highly profitable and robust to transaction costs, out of sample hedge ratio forecasts and risk management rules. Overall, the analysis supports the view that the VIX futures basis does not accurately reflect the mean-reverting properties of the VIX spot index but rather reflects a risk premium that can be harvested.
New research papers related to existing strategies:
#12 – Pairs Trading with Stocks
Chen, Chen, Li: Empirical Investigation of an Equity Pairs Trading Strategy
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1361293
Abstract:
We show that an equity pairs trading strategy generates large and significant abnormal returns. We then examine the economic drivers of this strategy. First, we find that this return is not driven purely by the short-term reversal of returns. Second, we decompose the pair-wise stock return correlations into those that can be explained by common factors (such as size, book-to-market, and accruals) and those that cannot. We find that the pairs correlations explainable by common factors drive most of the pairs trading returns. Third, the value-weighted profits of pairs trading are higher in firms in a richer information environment, and our trading strategy performs poorly in the recent liquidity crisis, suggesting that the pairs trading profits are not primarily driven by the delay in information diffusion and liquidity provision. Finally, consistent with the adaptive market efficiency theory, the return to this simple pairs trading strategy has diminished over time.
