Momentum has its moments

Risk Adjusted Momentum Strategies: A Comparison between Constant and Dynamic Volatility Scaling Approaches

“…To adopt the volatility scaling appraches, the first step is to estimate this volatility. Here, we calculate the 6-month realised volatility using the method of Barroso and Santa-Clara (2015), which is an average of squared previous 126 daily returns. The equation is shown as follows:…”

“…To address this issue, volatility scaling methods are used to avoid risks of momentum strategies, see, e.g., Boguth et al (2011), Wang and Xu (2015), Barroso and Santa-Clara (2015) and Daniel and Moskowitz (2016).…”

“…According to recent literature, there are two prevalent volatility scaling methods: (i) the Constant Volatility Scaling Approach (henceforth, CVS) documented by Barroso and Santa-Clara (2015), and (ii) the Dynamic Volatility Scaling Approach (henceforth, DVS) of Daniel and Moskowitz (2016). A CVS momentum strategy weights different instruments in the portfolio based on the ratio between a constant target volatility and realised volatility.…”

“…In contrast, a DVS momentum strategy weights its instruments depending on the ratio between the expected market returns and realised volatility. Both approaches perform efficiently in U.S stock markets as seen in Barroso and Santa-Clara (2015) and Daniel and Moskowitz (2016), but it is still under debate that which one is better.…”

“…Barroso and Santa-Clara (2015) argue that the main risks of momentum strategies are the systematic risks which account for 87% of total risks. Hence, they introduce the CVS to control for systematic risks.…”