Investment Horizon Increases Research Articles

Revisiting the performance of the scaled momentum strategies

PurposeThe main purpose of this study is to enunciate the underlying factors that enhance the performance of scaled momentum strategies.Design/methodology/approachIn previous studies, the negative relationship between the lagged volatility and future return of momentum strategy is exploited to manage the risk. But this negative relationship only holds when volatility is higher, further the volatility is shown to be persistent. The implication of these two characteristics is important and this paper highlights that.FindingsThe higher performance of the scaled momentum strategies for the US market is linked with the length of the investment horizon. The traditional asset pricing models fail to explain this relationship. However, the authors find that the excess variance loaded on the long side of these strategies is one important explanation of this horizon bound performance of these strategies.Practical implicationsThis study highlights that the volatility scaled momentum strategy has higher gains as the investment horizon increases. Therefore, it is an advisable investment strategy for the pension fund industry.Originality/valueMomentum strategy is unique as it fulfils two criteria of performance enhancement through volatility scaling, such as, the persistent in volatility and its negative relationship with the returns. However, the impact on the performance of the negative relationship between volatility and return that only exist in highest volatility related states is not discussed. The authors have shown that this aspect of volatility and return relationship of the momentum strategy has an important bearing on the performance of the volatility scaled momentum strategies.Highlights of the PaperThis study finds that the Sharpe ratios and the alphas of the volatility scaled strategies increase as the investment horizon increases.This is because the volatility series are highly persistent and the negative predictive relationship between the volatility and future momentum returns only exist when the volatility is higher. The impact of these two characteristics of the volatility series on the performance of the scaled momentum strategies is not discussed in the literature.We find that the scaled strategies invest more/less when the volatility of the momentum strategy is lower/higher. By investing less when volatility is higher, the scaled strategies avoid momentum crashes and lessens the contribution of the variance from the short side in the overall variance of these strategies.It is further shown that the higher performance of the volatility scaled strategies, at each investment related horizon can be explained by the higher variance loaded on the long side of such strategies in comparison to the traditional momentum strategy.

A PERFORMANCE ANALYSIS OF DOLLAR-COST AVERAGING AND SELF-ANNUITIZATION

The return and risk of dollar-cost averaging (DCA) and self-annuitization (SA) investing are compared with the underlying return in this paper. The underlying return, which is assumed to be normally distributed, is generated by Monte Carlo simulations under six market scenarios including upward and mean reverting markets across several investment horizons. Owing to the multiple cash flows of DCA and SA, the annual internal rate of return is used to measure the DCA and SA returns. The results show that the mean return of DCA is slightly higher than the underlying return, while the SA is lower, particularly under short investment horizons. Both DCA and SA produce higher return volatility and riskiness than the underlying return. They also create negative skewness and excess kurtosis for the return distributions. For comparing their performances, we use the economic performance measure which can consider those high moments of distribution. Except for the mean reverting market, the underlying return is the best performer, while SA is the worst. This evidence becomes even clearer and convincing as the investment horizon increases. DCA can have lower riskiness and perform better only under the mean reverting market.

O Ouro Atua Como Hedge ou Valor Refúgio Diante de Desvalorizações da BM&FBOVESPA?

Neste trabalho analisamos a capacidade do ouro em preservar o valor de uma carteira de investimentos composta por ações negociadas na Bolsa de Valores de São Paulo (BM&FBovespa) diante de variações extremas do mercado. Para tanto, utilizamos um teste de razão de verossimilhança baseado na estrutura de dependência entre o ouro e o Índice Brasil 100 (IBr X 100). Investigamos se quando esse índice experimenta uma forte queda, o ouro responde com o crescimento extremo de valor ou vice-versa. Inicialmente, a partir da teoria dos valores extremos (TVE), identificamos movimentos extremos em ambos os mercados. Assim, pudemos analisar a relação entre o ouro e o mercado acionário brasileiro através da formulação de várias hipóteses sobre a dependência condicional entre ambos. Utilizando dados diários da cotação do mercado de ações e do ouro referentes ao período compreendido entre janeiro de 2000 e março de 2015, encontramos evidências de que o ouro atua como hedge e como fraco valor refúgio diante de movimentos do mercado acionário.

Fundos Comportamentais possuem Desempenho Superior? Uma Análise baseada em Evidências Internacionais

Este trabalho analisou o desempenho de 31 fundos mútuos comportamentais atuantes nos EUA, Europa e Japão descritos em Santoni e Kelshiker (2010). Foram observados os desempenhos dos fundos e seus respectivos Benchmarks em quatro indicadores: Índice de Sharpe, Índice de Sortino, Medida Ômega e Medida de Desempenho Comportamental. O horizonte da análise foi de 10 anos (jan/04 a dez/14) dividido em intervalos de 6, 12, 36, 60 e 120 meses. A partir da consolidação dos indicadores os fundos foram ranqueados e classificados em três faixas de desempenho: superior, intermediário e inferior. No intervalo de 120 meses não houve, na média geral, diferença de desempenho significativa (a 5%) entre os fundos e os Benchmarks. A análise por intervalos indicou que o desempenho dos fundos em relação aos Benchmarks piora conforme aumenta o prazo de aplicação. Nos intervalos mais curtos (6 e 12 meses) não houve, na média, diferença de desempenho significativa enquanto nos prazos mais longos (36 e 60 meses) o desempenho médio dos fundos foi significativamente inferior aos Benchmarks. Na média de todos os intervalos o desempenho médio dos fundos foi significativamente inferior aos Benchmarks.

Inflation-Protecting Asset Allocation:A Downside Risk Analysis

This article studies the inflation-protection qualities of cash, bonds, stocks, and direct real estate, and the optimal inflation-protecting asset allocations within a downside risk framework. Using a value-at-risk model to capture predictable price dynamics, the authors find that the inflation-hedging properties of assets substantially change over the investment horizon. Cash is clearly the best hedge against inflation in the short run. However, as the investment horizon increases, bonds, stocks, and real estate become the more attractive options, with real estate exhibiting the best inflation-protection qualities on a medium- and long-term basis. While cash plays the most important role in short-term portfolios, the weights of the inflation-protecting portfolios shift to real estate, stocks, and bonds as the investment horizon increases.

Abstract, classic, and explicit turnpikes

Portfolio turnpikes state that as the investment horizon increases, optimal portfolios for generic utilities converge to those of isoelastic utilities. This paper proves three kinds of turnpikes. In a general semimartingale setting, the abstract turnpike states that optimal final payoffs and portfolios converge under their myopic probabilities. In diffusion models with several assets and a single state variable, the classic turnpike demonstrates that optimal portfolios converge under the physical probability. In the same setting, the explicit turnpike identifies the limit of finite-horizon optimal portfolios as a long-run myopic portfolio defined in terms of the solution of an ergodic HJB equation.

Leveraged ETFs: Admissible Leverage and Risk Horizon

This paper provides a quantitative risk analysis of leveraged ETFs (LETFs) with a focus on the impact of leverage and investment horizon. From the empirical returns of several major LETFs based on the S&P 500 index, the performance of LETFs generally declines as investment horizon increases, compared to the reference index. The value erosion is more severe for highly leveraged ETFs. To better understand the risk impact of leverage, we introduce the admissible leverage ratio induced by a risk measure, for example, value-at-risk (VaR) and conditional VaR. This idea can help investors exclude LETFs that are deemed too risky. Moreover, we also discuss the concept of admissible risk horizon so that the investor can control risk exposure by selecting an appropriate holding period. In addition, we also compute the intra-horizon risk, which leads us to evaluate a stop-loss/take-profit strategy for LETFs. Lastly, we investigate the impact of volatility exposure on the return of different LETF portfolios.

Private and Public Real Estate: What Is the Link?

Equity investments in commercial real estate are made through private transactions or public markets. Private and public investments include core real estate—the passive management of existing income generating properties—as well as value-added and opportunistic investments that focus on the active development of existing and new properties. Both forms of investment provide exposure to the same property market. Yet by conventional measures, public and private investments offer surprisingly different return and risk profiles. In this article, the authors focus on equity investment in core real estate in the U.K. market, analyzing data spanning more than two decades. They demonstrate a strong link between the returns to public and private real estate by correcting for appraisal smoothing and for the lead–lag relationship between public and private returns. They also discuss how real estate risk changes over longer horizons. In particular, the correlation between private and public returns strengthens as the investment horizon increases. These results have important implications for both risk management and asset allocation. As an example, they illustrate how the diversification benefits of real estate depend on the investment horizon and the amount of leverage employed.

Investment horizon effect on asset allocation between value and growth strategies

How does the optimal risk exposure of assets change as their investment horizons increase? Does this impact investment portfolio decision-making, in particular, optimal asset allocation between value and growth strategies over various investment horizons? This paper adopts a new approach to address these questions by examining portfolio allocation between value and growth stocks over various investment horizons. This new approach is based on wavelet analysis, which decomposes the returns of a particular investment strategy across multiple investment horizons. The key empirical results show that the success of pursuing the value strategy (short-selling growth stocks and going long on value stocks) is impacted by the approach used to classify value and growth stock returns. We explore two common alternatives: Fama–French versus Standard & Poor's (S&P) 500/Barra portfolios. The results using Fama–French portfolios show that as the investment horizon increases, the optimal mean allocation of investors tilts heavily away from growth stocks, particularly for lower and moderate levels of risk aversion. Interestingly, for S&P 500/Barra portfolios the allocation weights between value and growth do not vary much.

Abstract, Classic, and Explicit Turnpikes

Portfolio turnpikes state that, as the investment horizon increases, optimal portfolios for generic utilities converge to those of isoelastic utilities. This paper proves three kinds of turnpikes. In a general semimartingale setting, the abstract turnpike states that optimal final payo ffs and portfolios converge under their myopic probabilities. In diffusion models with several assets and a single state variable, the classic turnpike demonstrates that optimal portfolios converge under the physical probability; meanwhile the explicit turnpike identifies the limit of fi nite-horizon optimal portfolios as a long-run myopic portfolio de fined in terms of the solution of an ergodic HJB equation.

Investment Horizon Effect on Asset Allocation between Value and Growth Strategies

How does the optimal risk exposure of assets change as their investment horizons increase? Does this impact investment portfolio decision-making, in particular, optimal asset allocation between value and growth strategies over various investment horizons? This paper adopts a new approach to address these questions by examining portfolio allocation between value and growth stocks over various investment horizons. This new approach is based on wavelet analysis, which decomposes the returns of a particular investment strategy across multiple investment horizons. The key empirical results show that the success of pursuing the value strategy (short-selling growth stocks and going long on value stocks) is impacted by the approach used to classify value and growth stock returns. We explore two common alternatives: Fama-French versus Standard & Poor’s (S&P) 500/Barra portfolios. The results using Fama-French portfolios show that as the investment horizon increases, the optimal mean allocation of investors tilts heavily away from growth stocks, particularly for lower and moderate levels of risk aversion. Interestingly, for S&P 500/Barra portfolios the allocation weights between value and growth do not vary much.

A Longer Look at the Asymmetric Dependence between Hedge Funds and the Equity Market

AbstractThis paper reexamines, at a range of investment horizons, the asymmetric dependence between hedge fund returns and market returns. Given the current availability of hedge fund data, the joint distribution of longer-horizon returns is extracted from the dynamics of monthly returns using the filtered historical simulation; we then apply the method based on copula theory to uncover the dependence structure therein. While the direction of asymmetry remains unchanged, the magnitude of asymmetry is attenuated considerably as the investment horizon increases. Similar horizon effects also occur on the tail dependence. Our findings suggest that nonlinearity in hedge fund exposure to market risk is more short term in nature, and that hedge funds provide higher benefits of diversification, the longer the horizon.

Safety First, Robust Dynamic Asset Pricing, and the Cross-Section of Expected Stock Returns

We investigate the implications of investors’ aversion to Knightian uncertainty for the cross-section of average stock returns. First, we derive the fundamental dynamic asset pricing equation in beta regression form of a robust investor concerned with Knightian uncertainty. Second, we provide empirical evidence that learning and uncertainty are both risk dimensions of systematic risk priced in the cross-section of stock returns. However, the risk premium component corresponding to uncertainty dominates the one corresponding to learning as investors’ investment horizon increases. Third, we report that a robust version of the intertemporal CAPM (ICAPM) explains average stock returns better than the four-factor model and the standard ICAPM.

Cointegration and Consumption Risks in Asset Returns

We argue that the cointegrating relation between dividends and consumption, a measure of long-run consumption risks, is a key determinant of risk premia at all investment horizons. As the investment horizon increases, transitory risks disappear, and the asset’s beta is dominated by long-run consumption risks. We show that the return betas, derived from the cointegration-based VAR (EC-VAR) model, successfully account for the cross-sectional variation in equity returns at both short and long horizons; however, this is not the case when the cointegrating restriction is ignored. Our evidence highlights the importance of cointegration-based long-run consumption risks for financial markets. (JEL G1, G12) How does the riskiness of equity returns change with investment horizon? We show that at long horizons, risks are dominated by long-run consumption risks in dividends, while at short horizons, additional price risks may also matter. The cointegrating relation between dividends and consumption (i.e., the longrun consumption beta of dividends) provides a measure of long-run risks in dividends. This cointegrating relation has important conceptual and empirical implications for measuring risks in asset returns at all horizons. Empirically, we document that consumption betas determined by the cointegrationbased vector-autoregression (EC-VAR) can account for the cross section of mean equity returns at both short and long horizons. This, however, is not the case when the cointegration restriction between consumption and dividends is ignored. Hence, our evidence highlights the economic importance of long-run

Long Run Risks and Equity Returns

We argue that investor concerns about the exposure of asset returns to permanent movements in consumption levels are a key determinant of the risk and return relation in asset markets. We show that as the investment horizon increases, (i) the return's systematic risk exposure (consumption beta) almost converges to the long-run relation between dividends and consumption, (ii) return volatility is increasingly dominated by dividend shocks. We find that most of the differences in risk premia, at short and long horizons, is due to the heterogeneity in the exposure to permanent risks in consumption. The long-run cross-sectional relation between risk and return provides a measure of the compensation for permanent risks in consumption. We find that the market compensation for these risks is large relative to that for transitory movements in consumption.

Long Run Risks and Equity Returns

We argue that investor concerns about the exposure of asset returns to permanent movements in consumption levels are a key determinant of the risk and return relation in asset markets. We show that as the investment horizon increases, (i) the return's systematic risk exposure (consumption beta) almost converges to the long-run relation between dividends and consumption, (ii) return volatility is increasingly dominated by dividend shocks. We find that most of the differences in risk premia, at short and long horizons, is due to the heterogeneity in the exposure to permanent risks in consumption. The long-run cross-sectional relation between risk and return provides a measure of the compensation for permanent risks in consumption. We find that the market compensation for these risks is large relative to that for transitory movements in consumption.

Optimal Estimation of the Risk Premium for the Long Run and Asset Allocation: A Case of Compounded Estimation Risk

It is well known that an unbiased forecast of the terminal value of a portfolio requires compounding at the arithmetic mean return over the investment horizon. However, the maximum-likelihood practice, common with academics, of compounding at the estimator of mean return results in upward biased and highly inefficient estimates of long-term expected returns. We derive analytically both an unbiased and a small-sample efficient estimator of long-term expected returns for a given sample size and horizon. Both estimators entail penalties that reduce the annual compounding rate as the investment horizon increases. The unbiased estimator, which is far lower than the compounded arithmetic average, is still very inefficient, often more so than a simple geometric estimator known to practitioners. Our small-sample efficient estimator is even lower. These results compound the sobering evidence in recent work that the equity risk premium is lower than suggested by post-1926 data. Our methodology and results are robust to extensions such as predictable returns. We also confirm analytically that parameter uncertainty, properly incorporated, produces optimal asset allocations, in stark contrast to conventional wisdom. Longer investment horizons require lower, not higher, allocations to risky assets.

Preferred by “All” and Preferred by “Most” Decision Makers: Almost Stochastic Dominance

While “most” decision makers may prefer one uncertain prospect over another, stochastic dominance rules as well as other investment criteria, will not reveal this preference due to some extreme utility functions in the case of even a very small violation of these rules. Such strict rules relate to “all” utility functions in a given class including extreme ones which presumably rarely represents investors' preference. In this paper we establish almost stochastic dominance (ASD) rules which formally reveal a preference for “most” decision makers, but not for “all” of them. The ASD rules reveal that choices which probably conform with “most” decision makers also solve some debates, e.g., showing, as practitioners claim, an ASD preference for a higher proportion of stocks in the portfolio as the investment horizon increases, a conclusion which is not implied by the well-known stochastic dominance rules.

Skewness in individual stocks at different investment horizons

This paper examines the (a)symmetry of several individual stock returns at different investment horizons: daily, weekly and monthly. While some asymmetries are observed in daily returns, they disappear almost completely in weekly and monthly returns. The explanation for this fact lies in the convergence to normality that takes place when the investment horizon increases. These features allow one to question several financial models; in particular, they question the preference for positive skewness as a factor for investments in stock markets.

On The Risk of Stocks in the Long Run

This paper examines the proposition that investing in common stocks is less risky the longer an investor plans to hold them. If the proposition were true, then the cost of insuring against earning less than the risk-free rate of interest should decline as the length of the investment horizon increases. The paper shows that the opposite is true even if stock returns are mean-reverting in the long run. The case for young people investing more heavily in stocks than old people cannot, therefore, rest solely on the long-run properties of stock returns. For guarantors of money-fixed annuities, the proposition that stocks in their portfolio are a better hedge the longer the maturity of their obligations is unambiguously wrong.