TY - JOUR
T1 - Momentum strategies based on reward-risk stock selection criteria
AU - Rachev, Svetlozar
AU - Jašić, Teo
AU - Stoyanov, Stoyan
AU - Fabozzi, Frank J.
PY - 2007/8
Y1 - 2007/8
N2 - In this paper, we analyze momentum strategies that are based on reward-risk stock selection criteria in contrast to ordinary momentum strategies based on a cumulative return criterion. Reward-risk stock selection criteria include the standard Sharpe ratio with variance as a risk measure, and alternative reward-risk ratios with the expected shortfall as a risk measure. We investigate momentum strategies using 517 stocks in the S&P 500 universe in the period 1996-2003. Although the cumulative return criterion provides the highest average monthly momentum profits of 1.3% compared to the monthly profit of 0.86% for the best alternative criterion, the alternative ratios provide better risk-adjusted returns measured on an independent risk-adjusted performance measure. We also provide evidence on unique distributional properties of extreme momentum portfolios analyzed within the framework of general non-normal stable Paretian distributions. Specifically, for every stock selection criterion, loser portfolios have the lowest tail index and tail index of winner portfolios is lower than that of middle deciles. The lower tail index is associated with a lower mean strategy. The lowest tail index is obtained for the cumulative return strategy. Given our data-set, these findings indicate that the cumulative return strategy obtains higher profits with the acceptance of higher tail risk, while strategies based on reward-risk criteria obtain better risk-adjusted performance with the acceptance of the lower tail risk.
AB - In this paper, we analyze momentum strategies that are based on reward-risk stock selection criteria in contrast to ordinary momentum strategies based on a cumulative return criterion. Reward-risk stock selection criteria include the standard Sharpe ratio with variance as a risk measure, and alternative reward-risk ratios with the expected shortfall as a risk measure. We investigate momentum strategies using 517 stocks in the S&P 500 universe in the period 1996-2003. Although the cumulative return criterion provides the highest average monthly momentum profits of 1.3% compared to the monthly profit of 0.86% for the best alternative criterion, the alternative ratios provide better risk-adjusted returns measured on an independent risk-adjusted performance measure. We also provide evidence on unique distributional properties of extreme momentum portfolios analyzed within the framework of general non-normal stable Paretian distributions. Specifically, for every stock selection criterion, loser portfolios have the lowest tail index and tail index of winner portfolios is lower than that of middle deciles. The lower tail index is associated with a lower mean strategy. The lowest tail index is obtained for the cumulative return strategy. Given our data-set, these findings indicate that the cumulative return strategy obtains higher profits with the acceptance of higher tail risk, while strategies based on reward-risk criteria obtain better risk-adjusted performance with the acceptance of the lower tail risk.
KW - Expected tail loss
KW - Momentum strategies
KW - Reward-risk stock selection criteria
KW - Risk-adjusted performance
KW - Stable Paretian distribution
UR - http://www.scopus.com/inward/record.url?scp=34447626971&partnerID=8YFLogxK
U2 - 10.1016/j.jbankfin.2007.02.006
DO - 10.1016/j.jbankfin.2007.02.006
M3 - Article
AN - SCOPUS:34447626971
VL - 31
SP - 2325
EP - 2346
JO - Journal of Banking and Finance
JF - Journal of Banking and Finance
SN - 0378-4266
IS - 8
ER -