32 Pages Posted: 31 Dec 2014 Last revised: 21 Jan 2015
Date Written: December 30, 2014
This paper follows Keller (2012), which introduced the Flexible Asset Allocation (FAA) concept. FAA is based on a weighted ranking score of historical asset returns (R), volatilities (V), and correlations to an equal weighted index (C). We call this “generalized momentum” since we assume persistence in the short-term, not only for R, but also for V and C. Portfolios were formed monthly from a specified quantile of assets with the highest combined score.
In this paper we generalize FAA, starting from a tactical version of Modern Portfolio Theory (MPT) proposed in Keller (2013). Instead of choosing assets in the portfolio by a weighted ordinal rank on R, V, and C as in FAA, our new methodology – called Elastic Asset Allocation (EAA) – uses a geometrical weighted average of the historical returns, volatilities and correlations, using elasticities as weights.
In order to avoid datasnooping (or curvefitting), we optimize the EAA model exclusively during a 50-year in-sample period (IS) from 1914 and apply these optimal IS parameters to test the model during an out-of-sample (OS) period from 1964-2014. The EAA model demonstrates impressive risk-adjusted and absolute OS performance over an equal weighted index for a variety of global asset universes.
Keywords: Tactical Asset Allocation, Momentum, Elasticities, Markowitz, MPT, minimum variance, maximum diversification, Sharpe, EW, smart beta
JEL Classification: C00, C10, G00, G11
Suggested Citation: Suggested Citation
Keller, Wouter J. and Butler, Adam, A Century of Generalized Momentum; From Flexible Asset Allocations (FAA) to Elastic Asset Allocation (EAA) (December 30, 2014). Available at SSRN: https://ssrn.com/abstract=2543979 or http://dx.doi.org/10.2139/ssrn.2543979
By Meb Faber
By Andrew Ang
By Meb Faber