Volatility-Adjusted Momentum

Abstract

Motivated by standard portfolio theory, this paper incorporates ex-ante volatility estimates in the construction of winner-minus-loser stock momentum portfolio. I find that over the 1927-2015 period this leads to an increase in the Sharpe ratio from 0.34 to 1.14 and strongly reduced crash risk. This result is driven, in part, by the under weighting of high-volatility loser stocks, which tend to perform well, and cannot be attributed to small caps. In an out-of-sample test on USD-denominated corporate bonds, similar improvements are found.

Keywords: momentum, cross-section, volatility, stocks, corporate bonds

JEL Classification: G11, G12, G14, E44