Optimization of Equity Momentum: (How) Does it Work?

32 Pages Posted: 2 Sep 2015  

Arco van Oord

Erasmus University Rotterdam (EUR) - Department of Econometrics; De Nederlandsche Bank

Date Written: August 31, 2015


Standard mean-variance optimized momentum outperforms the traditional equally weighted momentum strategy if the expected return vector used reflects momentum's top and bottom only characteristic. This top and bottom only characteristic is the phenomenon that only the stocks in the top decile of momentum's ranking outperform and that only stocks in the bottom decile underperform, while all stocks in the intermediate deciles of the ranking have similar performance. If the optimization does not take this phenomenon into account the portfolio is also long the deciles 2 to 5 and short the deciles 6 to 9, while all these positions thus do not add anything to the return of the strategy. A new simplified bootstrapping methodology shows that the Sharpe-ratio of 52.8 percent of the optimized portfolio is significantly higher (p-value of 0.006) than the Sharpe-ratio of 29.3 percent for traditional equally weighted momentum. The optimized portfolio also exhibit less time-varying equity risk factor return exposures than traditional momentum and as such have more stable returns over the business cycle and have smaller drawdowns.

Keywords: Momentum, Mean-variance optimization, Time-varying risk, Sharpe-ratio, Bootstrap

Suggested Citation

van Oord, Arco, Optimization of Equity Momentum: (How) Does it Work? (August 31, 2015). Available at SSRN: https://ssrn.com/abstract=2653680 or http://dx.doi.org/10.2139/ssrn.2653680

Arco J.A. van Oord (Contact Author)

Erasmus University Rotterdam (EUR) - Department of Econometrics ( email )

P.O. Box 1738
Rotterdam, 3000 DR

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB

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