1
$\begingroup$

In the paper "Momentum has its moments" (Pedro Barroso and Pedro Santa-Clara, 2012 - available free from Nova Business School), the authors claim that there is a way to avoid momentum crash (caused by the short leg as the market rebounded following large previous declines, in other words the short leg rise with the market and cause great loses). They using the realized variance computed as the sum of the squared returns of the momentum strategy as a predictor. The question is how and why the realized variance can predict the point where the market start to rebound after large declines?

$\endgroup$

1 Answer 1

3
$\begingroup$

You are right, the authors provide no strong justification for why their method works. They just show that "it would have worked well in the past". But we should be skeptical how well it will work in the future, especially when you consider what a big improvement this simple change makes in the strategy; it seems a little too good to be true. This is a reasonable criticism of the paper. I suppose we will have to wait until the next big "momentum crash" and see what happens...

$\endgroup$
3
  • 1
    $\begingroup$ It's very interesting because when i run backtest with R it's indeed almost double the sharp ratio as the paper suggest (in fact i don't use the entire methodology, i use only the realized variance that is one component in the authors calculation, for me the realized variance is the predictor to the point of rebounded market, and in consequence the time to switch to risk free asset). More specifically the extreme high points of the realized variance predict very good the point of market rebound, but still i don't understand why? more generally what the realized variance can tell me? $\endgroup$
    – yudyud
    Oct 4, 2017 at 11:01
  • $\begingroup$ This letter by Shaik mentioned a similar approach to momentum using volatility in 2011, before the Pedros' article of 2012. business.nasdaq.com/media/… $\endgroup$
    – Alex C
    Nov 4, 2017 at 10:38
  • $\begingroup$ This is interesting. How do you understand their methodology? sorting to groups by cumulative return and then sorting by volatility within these groups? $\endgroup$
    – yudyud
    Nov 13, 2017 at 14:14

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service and acknowledge you have read our privacy policy.

Not the answer you're looking for? Browse other questions tagged or ask your own question.