Trend-Following Strategies for Tail-Risk Hedging and Alpha Generation

36 Pages Posted: 9 May 2018

Date Written: April 23, 2018

Abstract

Because of the adaptive nature of position sizing, trend-following strategies can generate the positive skewness of their returns, when infrequent large gains compensate overall for frequent small losses. Further, trend-followers can produce the positive convexity of their returns with respect to stock market indices, when large gains are realized during either very bearish or very bullish markets. The positive convexity along with the overall positive performance make trend-following strategies viable diversifiers and alpha generators for both long-only portfolios and alternatives investments.

I provide a practical analysis of how the skewness and convexity profiles of trend-followers depend on the trend smoothing parameter differentiating between slow-paced and fast-paced trend-followers. I show how the returns measurement frequency affects the realized convexity of the trend-followers. Finally, I discuss an interesting connection between trend-following and stock momentum strategies and illustrate the benefits of allocation to trend-followers within alternatives portfolio.

Keywords: Trend-Following, CTA, Tail Risk Hedging, Quantitative Investment Strategies, Alpha, Skewness

JEL Classification: G10, G11, G12

Suggested Citation

Sepp, Artur, Trend-Following Strategies for Tail-Risk Hedging and Alpha Generation (April 23, 2018). Available at SSRN: https://ssrn.com/abstract=3167787 or http://dx.doi.org/10.2139/ssrn.3167787

Artur Sepp (Contact Author)

Quantica Capital AG ( email )

Zurich
Switzerland

HOME PAGE: http://artursepp.com

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