Investment Horizon Related Momentum in Volatility Scaled Momentum Strategies

Abstract

Recent studies have shown that the Sharpe ratio and alpha for the momentum strategy can be increased, by scaling the momentum strategy, by the inverse of its historical volatility. However, we find that the higher Sharpe ratio and the alphas of the volatility scaled momentum strategy, in comparison to traditional momentum strategy, depends on the length of the investment horizon. Such that, the longer the investment horizon the better is the performance of the volatility scaled momentum strategy. It is further shown that the higher returns associated with volatility scaled strategies for different horizons have no risk-based explanation and instead linked with the variance of long side of scaled strategies. The main underpinning of these findings is the persistence in the volatility of momentum strategy and its negative predictive relationship with momentum returns that only exist when volatility of momentum strategy is higher.