Risk-Managed Industry Momentum and Momentum Crashes

On Industry Momentum Strategies

“…Notice that cumulative past returns in the formation period increase linearly as we move across strategies from group 1 to group 5. These results are consistent with Grobys, Ruotsalainen, and Äijö (2018), who report spreads of 76 and 106 basis points for the 6-1-1 and 12-1-1 strategies, respectively. The descriptive statistics in Table 2 indicate that skewness risk is lowest for the 1-0-1 strategy.…”

“…The realized volatility of the 1-0-1 zero-cost strategy is plotted in Figure I. Visual inspection reveals that the realized volatility of this proposed strategy exhibits patterns similar to those of the 12-1-1 industry momentum strategy, as documented in Figure I in Grobys, Ruotsalainen, and Äijö (2018).…”

“…Also, Su (2011) documents significant abnormal profits for industry momentum strategies in Chinese stock markets. 1 In recent papers, Plessis and Hallerbach (2016) and Grobys, Ruotsalainen, and Äijö (2018) examine the profitability of risk-managed momentum payoffs using U.S. industry portfolios. They employ risk-managed approaches by Barroso and Santa-Clara (2015) and Moreira and Muir (2017), who suggest the use of realized volatilities as a scaling factor to increase the dollar amount invested in industry momentum when forecast volatility is beneath the target level of volatility, and to decrease the dollar amount invested in the strategy otherwise.…”

“…Applying a similar risk-managing approach as proposed by Barroso and Santa-Clara (2015), and controlling for the spread of the plain 52-week high industry momentum strategy, on average 25 basis points higher risk-adjusted returns were earned. Plessis and Hallerbach (2016), Grobys, Ruotsalainen, and Äijö (2018), and Grobys (2018) argue that the respective investment strategies implemented using U.S. industries are significantly correlated with the market factor (i.e., CRSP [Compustat and Center for Research in Security Prices] index excess returns) but lack correlations with other factors in the Fama and French (1993) three-factor model. Hence, their findings implicitly support Lewellen, Nagel, and Shanken (2010), who observe that the factor structure of U.S. industry portfolios is different from equity portfolios sorted by characteristics such as size and book-to-market ratios.…”

“…where r 1−0−1, t is the strategy's unscaled payoff at time t, − − * r t 1 0 1 , is the scaled or risk-managed momentum payoff, and σ target is a constant corresponding to the target level of volatility. As documented in Barroso and Santa-Clara (2015), scaling corresponds to weighting the long and short legs differently from one another conditional on time t. We follow Barroso and Santa-Clara (2015) and Grobys, Ruotsalainen, and Äijö (2018) in choosing σ target = 12%. As in Moreira and Muir (2017), both unconstrained and leverageconstrained volatility-managed payoffs are estimated.…”