Journal of Risk Model Validation

Risk.net

Risk reduction in a time series momentum trading strategy

KiHoon Hong, KiBong Park and Yong Woong Lee

  • We study four most commonly used risk measures of a time series momentum (TSM) trading strategy.
  • The four measures include return volatility, beta, Value at Risk and Stressed Value at Risk.
  • We show that the TSM strategy reduces risk measures compared to the passive buy and hold strategy.
  • This should be relevant to anyone who manages financial risk of trading strategies based on TSM.

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.

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