New strategy:
#319 – Combined Stock and CDS Momentum
Period of rebalancing: monthly
Markets traded: equities
Instruments used for trading: stocks
Complexity: Complex strategy
Bactest period: 2003-2014
Indicative performance: 16.86%
Estimated volatility: 14.29%
Source paper:
Lee, Naranjo, Sirmans: Related Securities and the Cross-Section of Stock Return Momentum: Evidence From Credit Default Swaps (CDS)
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2819774
Abstract:
We document that related securities linked through firm fundamentals provide important cross-market return performance information. Using 1,074 firms during 2003-2014, we find stock return momentum for “joint” winners/losers whose past stock and CDS returns are in congruence, whereas return reversal for “disjoint” entities whose past stock returns disagree with their past CDS returns. Stock strategies combining momentum on joint winners/losers with contrarian on disjoint winners/losers outperform traditional stock momentum by 132 bps per month with an annualized Sharpe ratio of 1.11. Relative pricing of credit across related securities explains, in part, the cross-section of stock return momentum.
New research paper related to existing strategies:
#4 – Overnight Anomaly
Muravyev, Ni: Why Do Option Returns Change Sign from Day to Night?
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2820264
Abstract:
The risk-premium embedded in S&P 500 index options is negative and large: delta-hedged returns for these options are -0.7% per day. Strikingly, this risk premium is driven purely by negative overnight option returns: When we decompose this premium into intraday (open-to-close) and overnight (close-to-open) components, we find that average overnight returns are -1% while intraday returns are actually positive, 0.3% per day. Similar return pattern holds across option types, maturities, and moneyness, as well as for equity and ETF options, and VIX futures. Conventional risk-based theories cannot explain the positive intraday returns. However, we show that option returns become positive intraday because option investors ignore the well-known fact that stock volatility is substantially higher intraday than overnight. Thus, option prices apparently fail to properly reflect perhaps the strongest volatility seasonality, suggesting that option market-makers are less rational than previously thought. Finally, other option investors appear also unaware of this anomaly, which may explain its persistence.
#14 – Momentum Effect in Stocks
Dolvin, Foltice: Where Has the Trend Gone? An Update on Momentum Returns in the U.S. Stock Market
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2813333
Abstract:
Prior studies find broad-based support for the efficacy of trading strategies based on momentum in stock returns. More recent studies, however, note a declining benefit relative to that identified in seminal studies on momentum. These recent studies, however, primarily examine time periods ending prior to or immediately following the 2008 financial crisis. Thus, we extend this line of research by exploring the profitability of momentum trading in the U.S. equity markets over the broader 1986 to 2015 time period. Our results for the earlier part of our sample period (i.e., 1986 to 2006) fall in line with previous studies, as we find a monotonic relationship between decile portfolios formed based on prior six month performance and their subsequent twelve month holding period excess returns. In contrast, when we evaluate more recent periods (i.e., 2007-2015 and 2010-2015), we find dramatically different results. In particular, alphas for the “winner” portfolio, which have historically been the highest, are actually negative during both sub-periods. Furthermore, the curvature of the recent portfolio return distribution is clearly no longer monotonic. Rather, it follows a more inverted U-shaped curve from the “winner” portfolio (P1) to the “loser” (P10) portfolio, with excess returns cresting around the fifth decile portfolio (P5). In fact, we find that the risk adjusted returns of the “winner” portfolio (P1) are significantly less than the middle portfolio (P5) for both recent sub-periods. These results suggest that individual and institutional investors seeking to profit from traditionally-based momentum trading strategies may need to rethink their approaches.
#118 – Time Series Momentum Effect
Hamill, Rattray, Hemert: Trend Following: Equity and Bond Crisis Alpha
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2831926
Abstract:
We study time-series momentum (trend-following) strategies in bonds, commodities, currencies and equity indices between 1960 and 2015. We find that momentum strategies performed consistently both before and after 1985, periods which were marked by strong bear and bull markets in bonds respectively. We document a number of important risk properties. First, that returns are positively skewed, which we argue is intuitive by drawing a parallel between momentum strategies and a long option straddle strategy. Second, performance was particularly strong in the worst equity and bond market environments, giving credence to the claim that trend-following can provide equity and bond crisis alpha. Putting restrictions on the strategy to prevent it being long equities or long bonds has the potential to further enhance the crisis alpha, but reduces the average return. Finally, we examine how performance has varied across momentum strategies based on returns with different lags and applied to different asset classes.
Two additional related research papers have been included into existing free strategy reviews during last 2 week:
#5 – FX Carry Trade
Kesse: Exchange Rates, Carry Trade Returns and Political Risks
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2813028
Abstract:
This paper elucidates the channels through which sovereign risk, exchange rates and currency risk premia are related. I show that the channels are different depending on whether a country is classified as emerging or an advanced economy. Generally, for emerging market economies, local sovereign risk factors, namely country-specific political risk and macroeconomic risk do play a significant role in the depreciation of the local currency relative to the U.S. dollar. Whilst there is no convincing evidence that local determinants of sovereign risk cause a depreciation of currencies of advanced economies before the 2007 financial crisis, I do find that political risk does matter for advanced economies in the post-crisis era. For both sets of economies, global factors also play an important role in the relationship between sovereign risk and exchange rates. Secondly, double-sorting 34 currencies into different portfolios based on the level of macro risk and political risk, I provide evidence that local determinants of sovereign risk are priced in the FX markets, i.e. they can forecast currency carry trade excess returns in the cross-section. Local political risk in particular seems to have become an important carry trade risk factor in the post-2007 financial crisis era. This is the first research to explain carry trade excess returns with local sovereign risk factors as against sovereign risk as a whole.
Related to multiple commodity futures long/short strategies, mainly to term-structure based strategies (like #22 – Term Structure Effect in Commodities) …
Ghoddusi: Maturity Structure of Commodity Roll Strategies: Evidence from the Energy Futures
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2820228
Abstract:
We investigate the maturity-structure of roll strategy returns in the energy futures markets. Our innovation is to report and analyze the risk/return profile, the Sharpe ratio, and the asset pricing loadings of rollover strategies based on futures contracts of the same underlying commodity but with maturities between two and 12 months. We find that a conditional rollover strategy, which takes a long position in backwardation and a short position in contango, delivers the highest Sharpe ratio for all commodities. While we don't observe a significant difference in terms of asset pricing beta for different roll positions, the Sharpe ratio tends to be higher for contracts with a shorter time to maturity. We also report some distinct patterns of maturity-structure across energy commodities. Findings of the paper have implications for managing commodity-based investments.
