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Using a Z-score Approach to Combine Value and Momentum in Tactical Asset Allocation

42 Pages Posted: 17 Dec 2010 Last revised: 15 Mar 2012

Peng Wang

TIAA Institute - Covariance Capital Management

Larry Kochard

affiliation not provided to SSRN

Date Written: January 29, 2011

Abstract

We present several active strategies for combining value and momentum strategies in a tactical asset allocation (TAA) framework. We refine the basic yield approach to valuation by standardizing the value signal using the Z-score. Such standardization not only enables us to directly compare valuation measures across asset classes, but also offers insight about each asset class’s absolute valuation by its own standard. Under the nonlinear approach, it helps to identify market peaks and bottoms. We improve the momentum strategy by considering both relative and absolute performances. In the combined tactical asset allocation model, this modification to momentum acts as a simple mechanism to adjust the importance of value and momentum strategies under different market conditions. Our combined model takes advantage of both short-term momentum effects and long-term mean-reversion in valuation to achieve superior overall portfolio performance. Finally, we also provide alternative models for smaller tracking errors.

Keywords: Value, Momentum, Tactical Asset Allocation, Dynamic Asset Allocation, TAA, Asset Classes, Z Score

Suggested Citation

Wang, Peng and Kochard, Larry, Using a Z-score Approach to Combine Value and Momentum in Tactical Asset Allocation (January 29, 2011). Available at SSRN: https://ssrn.com/abstract=1726443 or http://dx.doi.org/10.2139/ssrn.1726443

Peng Wang (Contact Author)

TIAA Institute - Covariance Capital Management ( email )

1221 McKinney St. Suite 1800
Houston, TX 77010
United States

Larry Kochard

affiliation not provided to SSRN ( email )

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