In this paper we investigate the risk-adjusted performance of US sector portfolios and sector rotation strategy using the alphas from the Fama-French five factor model. We find that fivefactor model fits better the returns of US sector portfolios than the three factor model, but that significant alphas are still present in all the sectors at some point in time. In the full sample period, 50% of sectors generate significant five-factor alpha. We test if such alpha signifies a true sector out/underperformance by applying simple long-only and long-short sector rotation strategies. Our long-only sector rotation strategy that buys a sector with a positive five-factor alpha generates four times higher Sharpe ratio than the S&P500 buy-and-hold. If the strategy is adjusted to switch to the risk-free asset in recessions, the Sharpe ratio achieved is ten-fold that of the buy-and-hold. The long-short strategy fares less well.
This is the accepted version of the paper.This version of the publication may differ from the final published version. Permanent repository link AbstractThis paper performs comparative analysis of the asymmetries in size, value and momentum premium and their macroeconomic determinants over the UK economic cycles, using Markov switching approach. We associate Markov switching regime 1 with economic upturn and regime 2 with economic downturn. We find clear evidence of cyclical variations in the three premiums, most notable being that in the size premium, which changes from positive in expansions to negative in recessions. Macroeconomic indicators prompting such cyclicality the most are variables that proxy credit market conditions, namely the interest rates, term structure and credit spread. Overall, macro factors tend to have more significant impact on the three premiums during economic downturns. The results are robust to the choice of information variable used in modelling transition probabilities of the two-stage Markov switching model. We show that exploiting cyclicality in premiums proves particularly profitable for portfolios featuring small cap stocks in recessions at a feasible level of transaction costs. JEL classification: G11, E32
In this study we estimate the survival time of momentum in six UK style portfolio returns from October 1980 to June 2014. We utilise the Kaplan-Meier estimator, a non-parametric method that measures the probability that momentum will persist beyond the present month. This probability enables us to compute the average momentum survival time for each of the six style portfolios. Discrepancies between these empirical mean survival times and those implied by theoretical models (Random Walk and ARMA (1, 1)) show that there is scope for profiting from momentum trading. We illustrate this by forming long-only, short-only and long-short trading strategies that exploit positive and negative momentum and their average survival time. These trading strategies yield considerably higher Sharpe ratios than the comparative buy-and-hold strategies at a feasible level of transaction costs. This result is most pronounced for the long/short strategies. Our findings remain robust during the 2007/08 financial crisis and the aftermath, suggesting that Kaplan-Meier estimator is a powerful tool for designing a profitable momentum strategy.
In this study we estimate the survival time of momentum in six UK style portfolio returns from October 1980 to June 2014. We utilise the Kaplan-Meier estimator, a non-parametric method that measures the probability that momentum will persist beyond the present month. This probability enables us to compute the average momentum survival time for each of the six style portfolios. Discrepancies between these empirical mean survival times and those implied by theoretical models (Random Walk and ARMA (1, 1)) show that there is scope for profiting from momentum trading. We illustrate this by forming long-only, short-only and long-short trading strategies that exploit positive and negative momentum and their average survival time. These trading strategies yield considerably higher Sharpe ratios than the comparative buy-and-hold strategies at a feasible level of transaction costs. This result is most pronounced for the long/short strategies. Our findings remain robust during the 2007/08 financial crisis and the aftermath, suggesting that Kaplan-Meier estimator is a powerful tool for designing a profitable momentum strategy. JEL classification: G14, G11
In this paper, we assess the relationship between risk-shifting of mutual funds, measured as benchmark-adjusted factor-based investment style change following a structural break, and their risk-adjusted performance. We isolate only the breaks in style risk beyond those embedded in the funds' benchmark index to eliminate any natural style risk changes resulting from varying company fundamentals over time. We group style risk changes into extreme (style rotation), moderate (style drifting), and weak (style-strengthening/weakening) and assess which investment style category is most profitable to shift in to and out of. Our findings show that funds that exhibit breaks generate overall better risk-adjusted performance than those that do not. Funds that are most successful in risk-shifting have both statistically and economically distinct risk-adjusted performance, make shifts towards small/large/value/growth style combinations rather than mid-cap and blend style, exhibit breaks less frequently and has more moderate risk-shifts than funds that are unsuccessful.
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