Risk Adjusted Time Series Momentum

65 Pages Posted: 23 Jun 2014 Last revised: 6 Jan 2015

Martin Dudler

Quantica Capital

Bruno Gmuer

Quantica Capital

Semyon Malamud

Ecole Polytechnique Federale de Lausanne; Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne; Centre for Economic Policy Research (CEPR)

Date Written: June 22, 2014

Abstract

We introduce a new class of momentum strategies, the risk-adjusted time series momentum (RAMOM) strategies, which are based on averages of past futures returns, normalized by their volatility. We test these strategies on a universe of 64 liquid futures contracts and show that RAMOM strategies outperform the time series momentum (TSMOM) strategies of Ooi, Moskowitz, and Pedersen (2012) for almost all combinations of holding and look-back periods. This outperformance is driven by the following new striking stylized fact that we document: For almost all of the 64 futures contracts, independent of the asset class, realized futures volatility is contemporaneously negatively related to the Fama and French (1987) market (MKT), value (HML), and momentum (UMD) factors. As a result, RAMOM returns have a natural, built-in exposure to the MKT, HML, and UMD factors and outperform TSMOM returns precisely in times when (some of) the factors deliver good returns. In particular, RAMOM allows investors to gain significant exposure to Fama and French factors without actually trading the very large stock universe. Furthermore, dollar turnover of RAMOM strategies is about 40% lower than that of TSMOM, implying a drastic reduction in trading costs.

We construct measures of momentum-specific volatility, both within and across asset classes, and show how these volatility measures can be used for risk management. We find that momentum risk management significantly increases Sharpe ratios, but at the same time may lead to more pronounced negative skewness and tail risk. Furthermore, momentum risk management leads to a much lower exposure to market, value, and momentum factors; as a result, risk-managed momentum returns offer much higher diversification benefits than those of standard momentum returns.

Keywords: momentum, risk, return, volatility, trend following

JEL Classification: C41; G11

Suggested Citation

Dudler, Martin and Gmuer, Bruno and Malamud, Semyon, Risk Adjusted Time Series Momentum (June 22, 2014). Swiss Finance Institute Research Paper No. 14-71. Available at SSRN: https://ssrn.com/abstract=2457647 or http://dx.doi.org/10.2139/ssrn.2457647

Martin Dudler

Quantica Capital ( email )

Freier Platz 10
Schaffhausen
Switzerland

Bruno Gmuer

Quantica Capital ( email )

Freier Platz 10
Schaffhausen
Switzerland

Semyon Malamud (Contact Author)

Ecole Polytechnique Federale de Lausanne ( email )

Lausanne, 1015
Switzerland

Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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