Momentum Strategies for Equity versus Derivatives: Application to Asia Portfolio Management

Abstract

This paper provides practical insight on the returns generated by momentum strategies in both the physical equity and derivative markets, specifically looking at warrants and options listed in six selected Asian Capital markets, namely (in alphabetical order), Hong Kong, Japan, Korea, Malaysia, Singapore, and Taiwan. Selection is based on the volume and density of transactions. We explore the feasibility of applying momentum strategies in constructing a well-diversified Asian portfolio while achieving profit maximization in all market conditions. Our results show that momentum profits are generally quite substantial across our six selected Asian capital markets for both equity and equity derivatives investment and more profitable for derivative markets than the underlying equity markets. We find that momentum investing is indeed less volatile than outright investing. Also, momentum investing is generally less correlated when Asian markets experience both positive and negative returns. We find weaker co-movement between the equity and equity derivative momentums than outright investing in both equity and equity derivatives instruments and correlations between equities investing are highest across the Asian countries. We show that the inclusion of equity derivatives in a portfolio is not redundant and by adding momentum equity derivatives in the portfolio, we indeed create a well-diversified Asian portfolio with significant positive returns. Profit maximization is better achieved by combining mainly the outright equities positions in our Asian portfolio than by investing in momentum strategies (the return from outright investing is much higher than from momentum investing). A well-diversified Asian portfolio is best created when it comprises momentum investments (the returns are superior and significant).