I read the paper "Momentum has its moments" (Pedro Barroso and Pedro Santa-Clara, 2012 - available free from Nova Business School), though i didn't fully understand something important, when speaking about changing weights on the WML the authors speaks about number that varies from 0.2 to 2, but since WML consist of long and short what these numbers mean for them? in other words, how can i interpret these numbers as a specific weight for the long and short legs? This question is not just for this specific paper.
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$\begingroup$ What other papers do you have in mind? $\endgroup$– Bob Jansen ♦Commented Sep 28, 2017 at 8:16
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$\begingroup$ Momentum Crashes (Kent Daniel and Tobias J. Moskowitz). A little bit different but the same idea. $\endgroup$– yudyudCommented Sep 28, 2017 at 8:22
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1 Answer
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Barroso and Santa-Clara recommend that for risk management reasons you "scale the leverage" of the WML strategy over time, and they provide a formula for doing so. Let's say you manage 1 million dollars. Sometimes you short 0.2 million of L stocks against long 0.2 million of W stocks, at other times when circumstances are more favorable you short 2 million of L (twice as much as your capital) against 2 million of W long. The leverage is a decision variable that you control (subject to an upper limit by your Prime Broker, of course, but 2 is realistic and even 3 or 4 is doable if you are crazy enough (good luck if things go wrong)).
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$\begingroup$ Hi! thanks for your answer. In first look that is what i thought, but then i noticed the following paragraph: "Scaling corresponds to having a weight in the long and short legs that is different from one and varies over time, but the strategy is still self-financing.". From this paragraph it seems that the long and short can be different, so i'm confuse.. how do you underdtand this paragraph? $\endgroup$– yudyudCommented Sep 28, 2017 at 17:35
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$\begingroup$ He did not say "weights in the long and short that are different from one" but "weight ... that is different from one". So I think the weight of the long and short are the same number. $\endgroup$– nbbo2Commented Sep 28, 2017 at 17:56
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$\begingroup$ Ok, understand. And how you understand the formula for the weight? to be more specific, the σ-target is a constant, σˆt- the variance forecast from daily returns as explained in the paper, but how do you understand the Rwml,t? these three suppose to give us the weight for the next month, am i right? $\endgroup$– yudyudCommented Sep 28, 2017 at 18:25
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$\begingroup$ Hi, one more question, you said that sometimes i will short 0.2 against long 0.2, and sometimes another level of leverage, these leverages that changes is always in relation to the basic amount? $\endgroup$– yudyudCommented Oct 1, 2017 at 11:01