Market Timing & Trading Strategies Using Asset Rotation

Abstract

In this paper we present empirical results on the statistical and economic viability of a market timing trading strategy that is based on rotation between two risky assets. We use data on Exchange Traded Funds (ETFs) and models for both the returns and the volatility of the underlying assets. We compare the performance of the suggested models with the standard benchmarks of a buy-and-hold strategy and an equally weighted portfolio. The underlying intuition for the use of such a strategy rests with literature on sign and volatility predictability. The rotation strategy, as we apply it in this paper, is not risk-neutral and assumes the presence of arbitrage opportunities in the markets. Our results show that even a naive model that is based on a moving average of relative returns can outperform both benchmarks and that more elaborate specifications for the rotation model may yield additional performance gains. We also find that, in many cases, the rotation strategy yields statistically significant sign predictions of the relative returns and volatility. While our results are particular to the data that we have used in our analysis they, nevertheless, support the market timing literature and show that an active trading strategy can be based on the concept of rotation.

Keywords: Exchange Traded Funds, forecasting, market timing, sign predictions, statistical arbitrage, technical trading, volatility timing

JEL Classification: C51, C53, G10