A New Analysis of Commodity Momentum Strategy

A related paper has been added to:

#21 – Momentum Effect in Commodities

Authors: Bianchi, Drew, Fan

Title: Microscopic Momentum in Commodity Futures

Link: https://www120.secure.griffith.edu.au/research/file/0a572b95-132b-419d-9a71-310420fad143/1/2015-10-microscopic-momentum-in-commodity-futures.pdf


Conventional  momentum strategies  rely  on 12 months of past returns for  portfolio formation. Novy-Marx  (2012)  shows that the intermediate  return  momentum strategy formed  using only twelve to  seven  months  of returns prior  to  portfolio  formation significantly outperforms the recent return momentum formed using six to two month returns  prior. This  paper proposes a more granular strategy  termed  ‘microscopic momentum’, which further decomposes the intermediate and recent return momentum into  single-month  momentum components. The  novel  decomposition  reveals that a microscopic  momentum  strategy  generates  persistent  economic profits  even  after controlling   for   sector-specific   or month-of-year   commodity   seasonality   effects. Moreover, we show that the intermediate return  momentum in the commodity  futures must  be  considered largely  illusory, and all 12  months of  past  returns play  important  roles in determining the conventional momentum profits.

Notable quotations from the academic research paper:

"In  this  study,  we  propose  a  third  type  of  momentum  strategy  termed Microscopic Momentum, which further decomposes the recent (6 to 2 months) and intermediate (12 to 7 months)  momentum  of  Novy-Marx  (2012)  into  12  single-month  individual momentum components. As a consequence of the decomposition, we are able to take a glimpse at momentum profits under a month-by-month, microscopic scale. For the first time,  this  novel  approach  not  only  reveals  a  striking  new  discovery  of  a  momentum based anomaly, but also allows us to pinpoint whether specific months in the past play a more significant role in determining conventional and echo momentum profits, hence it offers fresh insights into our understanding of momentum in commodity futures.

The proposed granular analysis of microscopic momentum makes four major contributions to the commodity futures literature. First, in the commodity futures markets, the ‘11,10 microscopic momentum strategy’, constructed using the 11 to 10-month return prior to formation, produces an annualised average return of 14.74% with strong statistical significance. The superiority of the 11,10 strategy is not driven by sector-specific nor month-of-year commodity seasonality effects and is robust across sub-periods  and  out-of-sample  analysis. 

Second,  when  the  RNM  echo  momentum  is regressed  against  its  microscopic  components,  RNM  intermediate  momentum  can  be completely   subsumed  by   the  11,10  microscopic  momentum.  Thus,  the  superior performance  of  intermediate  momentum  claimed by  RNM may  be  an  illusion  created by  the  11,10  microscopic  momentum.  This  implies  that  for  tactical  asset  allocation decisions,  CTAs  and  commodity  fund  managers  must  not  consider  intermediate momentum  as  a  viable  substitute  for  conventional  momentum  strategies. Instead,  the 11,10  microscopic  strategy,  which  offers  similar  profits  in  magnitude  but  unique dynamics of returns to conventional strategies, may be a feasible alternative.

Third, around 77% of the variation of returns in the JT conventional momentum strategy can be explained by its microscopic decomposition. However, since no dominance is found on any individual month, all past months are found to be important in determining the conventional commodity momentum profits.

Fourth, echo and microscopic  momentum  is  partially  related  to  the  U.S.  cross-sectional  equity momentum and the returns from broad commodity futures, but is not related to stocks, bonds,  foreign currency risks and macroeconomic  conditions. Consistent with  Asness et. al., (2013), this finding implies that there may  indeed be a  common component in momentum across asset classes."

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