Active Momentum Trading versus Passive '1/N Naive Diversification'

22 Pages Posted: 14 Jun 2013

See all articles by Anurag Narayan Banerjee

Anurag Narayan Banerjee

Durham Business School

Chi-Hsiou Daniel Hung

University of Glasgow - Adam Smith Business School

Date Written: November 1, 2011

Abstract

We consider a passive 1/N naive diversification strategy which is long in the equally weighted portfolio of stocks feasible for trading and short in the risk-free asset. We then examine the profi…tability, exposures to risk factors, idiosyncratic variance as well as the relation between the momentum and the 1/N naive diversifi…cation strategies. The set of sample stocks that we use to construct the equally weighted portfolio is the same as that for constructing the momentum strategies. We fi…nd that both strategies generate an average pro…t of 1% per month. The differences in raw and risk-adjusted pro…ts between these two strategies are statistically and economically insignifi…cant. These two strategies are independent of each other. The idiosyncratic variance of the momentum strategies is 20 times higher than that of the naive diversifi…cation strategy. The findings are consistent over the period between 1926 and 2005 and various sub-sample periods including the periods examined in Jegadeesh and Titman (1993 and 2001) and in our simulations where we randomly select 10 years for 100 times. The results also hold when we conduct tests in sub-samples where we divide the sample, each month, into two groups of large and small size stocks.

Suggested Citation

Banerjee, Anurag Narayan and Hung, Chi-Hsiou Daniel, Active Momentum Trading versus Passive '1/N Naive Diversification' (November 1, 2011). Available at SSRN: https://ssrn.com/abstract=2279336 or http://dx.doi.org/10.2139/ssrn.2279336

Anurag Narayan Banerjee

Durham Business School ( email )

Mill Hill Lane
Durham, Durham DH1 3LB
United Kingdom

Chi-Hsiou Daniel Hung (Contact Author)

University of Glasgow - Adam Smith Business School ( email )

Gilbert Scott Building
University of Glasgow
Glasgow, Scotland G12 8QQ
United Kingdom

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