Abstract
This paper examines volatility interdependencies between value and momentum returns. Using U.S. data over the period 1926-2015, we document persistent periods of low and high volatility spillovers between value and momentum strategies. Moreover, we find that the intensity of the volatility spillovers may change substantially in very short periods of time and that these shifts in spillover intensity can be linked to prominent economic events and financial market turmoil. Our results further demonstrate that value returns increase and momentum returns decrease monotonically with increasing volatility spillovers between the two strategies. Given this linkage between spillover intensity and returns, we propose a simple trading strategy which utilizes a volatility spillover index for allocating funds between value and momentum portfolios. The proposed trading strategy outperforms value and momentum strategies and generates payoffs that are not subject to option-like behavior.
Highlights
Over the last 2 decades, considerable attention in asset pricing studies has been devoted to the performance and risk characteristics of value and momentum strategies
We estimate monthly realized volatilities of the value and momentum returns, and employ the volatility spillover index framework proposed by Diebold and Yilmaz (2009) to examine the intensity of volatility spillovers between the returns of value and momentum portfolios over time
In the aftermath of major events, the volatilities of both strategies are more likely to be driven by a common uncertainty factor, whereas periods of low volatility spillover intensity tend to coincide with economic recessions
Summary
Over the last 2 decades, considerable attention in asset pricing studies has been devoted to the performance and risk characteristics of value and momentum strategies. As noted by Asness et al (2013), value and momentum effects in stock returns are two of the most examined financial market anomalies which have become focal points of the asset pricing literature. These two strategies are widely used by practitioners. We estimate monthly realized volatilities of the value and momentum returns, and employ the volatility spillover index framework proposed by Diebold and Yilmaz (2009) to examine the intensity of volatility spillovers between the returns of value and momentum portfolios over time. The sample period is from December 1926 to September 2015
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