New strategies:
#263 – Economic Momentum in Currencies
Period of rebalancing: monthly
Markets traded: currencies
Instruments used for trading: futures, CFDs, forwards, swaps
Complexity: Very complex strategy
Bactest period: 1976 – 2014
Indicative performance: 6.15%
Estimated volatility: 5.60%
Source paper:
Dahlquist, Hasseltoft: Economic Momentum and Currency Returns
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2579666
Abstract:
Past trends in a broad range of fundamental variables predict currency returns. We document that a trading strategy that goes long currencies in countries with strong economic momentum and short currencies in countries with weak economic momentum exhibits an annualized Sharpe ratio of about one and yields a significant alpha when controlling for standard carry, momentum, and value strategies. The economic momentum strategy subsumes the alpha of carry trades, suggesting that cross-country differences in carry are captured by differences in past economic trends. Moreover, we study investors’ expectations of fundamental variables and find the expectations to be extrapolative but negatively related to the portfolio weights, which rank economic trends across countries.
New research papers related to existing strategies:
#6 – Volatility Effect in Stocks – Long-Short Version
#7 – Volatility Effect in Stocks – Long-Only Version
#77 – Beta Factor in Stocks
Schneider, Wagner, Zechner: Low Risk Anomalies?
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2593519
Abstract:
This paper shows theoretically and empirically that beta- and volatility-based low risk anomalies are driven by return skewness. The empirical patterns concisely match the predictions of our model that endogenizes the role of skewness for equity returns through credit risk. We show that ex-ante skewness predicts equity returns and that the prevalence of low risk anomalies depends on the skewness of the firms' underlying return distributions. Betting against beta or volatility is profitable for firms with high downside risk but generates losses among firms with less negative or positive ex-ante skewness. Since skewness is directly connected to default risk, our results also provide new insights for the distress puzzle.
#6 – Volatility Effect in Stocks – Long-Short Version
#7 – Volatility Effect in Stocks – Long-Only Version
#77 – Beta Factor in Stocks
Baker, Wurgler: Do Strict Capital Requirements Raise the Cost of Capital? Bank Regulation, Capital Structure, and the Low Risk Anomaly
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2577963
Abstract:
Traditional capital structure theory predicts that reducing banks’ leverage reduces the risk and cost of equity but does not change the weighted average cost of capital, and thus the rates for borrowers. We confirm that the equity of better-capitalized banks has lower beta and idiosyncratic risk. However, over the last 40 years, lower risk banks have not had lower costs of equity (lower stock returns), consistent with a stock market anomaly previously documented in other samples. A calibration suggests that a binding ten percentage-point increase in Tier 1 capital to risk-weighted assets could double banks’ risk premia over Treasury bills.
#28 – Value and Momentum across Asset Classes
Bhansali, Davis, Dorsten, Rennison: Carry and Trend in Lots of Places
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2579089
Abstract:
Investors intuitively know two fundamental principles of investing: (1) Don’t fight the trend, (2) Don’t pay too much to hold an investment. But do these simple principles actually lead to superior returns? In this paper we report the results of an empirical study covering twenty major markets across four asset classes, and an extended sample period from 1960 to 2014. The results confirm overwhelmingly that having the trend and carry in your favor leads to significantly better returns, on both an absolute and a risk-adjusted basis. Furthermore, this finding appears remarkably robust across samples, including the period of rising interest rates from 1960 to 1982. In particular, we find that while carry predicts returns almost unconditionally, trend-following works far better when carry is in agreement. We believe that this simple two-style approach will continue to be an important insight for building superior investment portfolios.
#207 – Value Effect within Countries
Novotny, Gupta: The Dynamics of Value Across Global Equity Markets: The Risk Contagion
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2589026
Abstract:
The ratio between the share price and current earnings per share, the PE ratio, is widely considered to be an effective gauge of under/overvaluation of a corporation’s stock. Arguably, a more reliable indicator, the Cyclically-Adjusted Price Earning ratio or CAPE, can be obtained by replacing current earnings with a measure of permanent earnings i.e. the profits that a corporation is able to earn, on average, over the medium to long run. In this study, we aim to understand the cross-sectional aspects of the dynamics of the valuation metrics across global stock markets including both developed and emerging markets. We use a time varying DCC model to exploit the dynamics in correlations, by introducing the notion of value spread between CAPE and the respective Market Index from 2002 to 2014 for 34 countries. We find periods, notably around the 2008 financial crisis, when the value spread shows large degree of variation and thus provide a statistically significant signal for the asset allocation. The signal can be utilized for better asset allocation as it allows one to interpret the common movements in the stock market for under/overvaluation trends. These estimates clearly indicate periods of misvaluation in our sample. Furthermore, our simulations suggest that the model would have been able to provide early warning signs of misvaluation in real time on a global scale and formation of asset bubbles.
#229 – Earnings Quality Factor
Landier, Simon, Thesmar: The Capacity of Trading Strategies
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2585399
Abstract:
Due to non-linear transaction costs, the financial performance of a trading strategy decreases with portfolio size. Using a dynamic trading model a la Garleanu and Pedersen (2013), we derive closed-form formulas for the performance-to-scale frontier reached by a trader endowed with a signal predicting stock returns. The decay with scale of the realized Sharpe ratio is slower for strategies that (1) trade more liquid stocks (2) are based on signals that do not fade away quickly and (3) have strong frictionless performance. For an investor ready to accept a Sharpe reduction by 30%, portfolio scale (measured in dollar volatility) is given by a simple formula that is a function of the frictionless Sharpe, a measure of price impact, and a measure of the speed at which the signal fades away. We apply the framework to four well-known strategies. Because stocks have become more liquid, the capacity of strategies has increased in the 2000s compared to the 1990s. Due to high signal persistence, the capacity of a "quality" strategy is an order of magnitude larger than the others and is the only one highly scalable in the mid-cap range.
Two additional related research paper have been included into existing free strategy reviews during last 2 week:
#5 – FX Carry Trade
Maurer, To, Tran: Pricing Risks Across Currency Denominations
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2589545
Abstract:
Investors based in different countries earn different returns on same strategies because the same risks covary differently with countries' stochastic discount factors (SDFs). We document that investors in low-interest-rate countries earn more than those in high-interest-rate countries on identical carry trade strategies. We propose a novel econometric procedure to estimate country-specific SDFs from foreign exchange market data. We provide out-of-sample evidence that (i) a country's interest rate is inversely related to its SDF volatility, (ii) output gap fluctuations across countries strongly correlate with estimated SDFs, and (iii) our estimated SDFs explain half of the risk in equity markets as measured by priced equity premia.
#21 – Momentum Effect in Commodities
#22 – Term Structure Effect in Commodities
Bakshi, Bakshi, Rossi: Understanding the Sources of Risk Underlying the Cross-Section of Commodity Returns
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2589057
Abstract:
We show that a model featuring an average commodity factor, a carry factor, and a momentum factor is capable of describing the cross-sectional variation of commodity returns. More parsimonious one- and two-factor models that feature only the average and/or carry factors are rejected. To provide an economic interpretation, we show that innovations in equity volatility can price portfolios formed on carry with a negative risk premium, while innovations in our measure of speculative activity can price portfolios formed on momentum with a positive risk premium. Furthermore, we characterize the relation of the factors with the investment opportunity set.
