Trend Momentum II: Driving Forces of Low Volatility and Momentum
46 Pages Posted: 13 Feb 2018
Date Written: February 8, 2018
In discussions and critiques on the validity of the Efficient Market Hypothesis, there are two important research focuses: statistical analyses showing that the basic assumption of statistical independence in price series is violated and empirical findings that show that significant market anomalies exist. In this work, we combine both viewpoints by analyzing two important mathematical factor anomalies: low volatility and momentum. By applying an explicit trend model, we show that both anomalies require trending. Additionally, we show that the trend model used exhibits log-normal trend characteristics. Furthermore, the model allows us to describe how low volatility uses implicitly asymmetric trend characteristics while momentum directly exploits trends. Using Mandelbrot’s model of fractional Brownian Motions, we can finally link statistical analyses (measuring the Hurst exponent and persistence in returns) to the empirically observed momentum factor. Experimentally, the Hurst exponent in itself allows for a momentum strategy, and it can also be utilized to significantly improve low volatility strategies. In contrast to Mandelbrot’s approach, we offer a non-stationary view that allows us to describe both investment strategies using the trend model.
Keywords: Momentum Effect, Low Volatility Effect, Efficient Market Theory, Mandelbrot, Fractional Brownian Motion
JEL Classification: G11, G12
Suggested Citation: Suggested Citation