Risk reduction in a time series momentum trading strategy

Abstract

In this paper, we investigate the four most commonly used risk measures - return volatility, beta, value-at-risk and stressed value-at-risk - of a time series momentum (TSM) trading strategy. We demonstrate that the TSM strategy results in reduced risk measures compared with the passive buy-and-hold strategy. We then validate the hypothesis with a bivariate risk model of AR(1) processes. The reduction in risk measures ranged from 24% to 46% under the given model of AR(1) processes. These findings should be relevant to portfolio managers, traders or risk managers who are interested in managing the financial risk of trading strategies based on TSM.