Momentum strategies in commodity futures markets

The article tests for the presence of short-term continuation and long-term reversal in commodity futures prices. While contrarian strategies do not work, the article identifies 13 profitable momentum strategies that generate 9.38% average return a year. A closer analysis of the constituents of the long–short portfolios reveals that the momentum strategies buy backwardated contracts and sell contangoed contracts. The correlation between the momentum returns and the returns of traditional asset classes is also found to be low, making the commodity-based relative-strength portfolios excellent candidates for inclusion in well-diversified portfolios.     

Economic linkages across commodity futures: Hedging and trading implications

We investigate cross-market trading dynamics in futures contracts written on seemingly unrelated commodities that are consumed by a common industry. On the Tokyo Commodity Exchange, we find such evidence in natural rubber (NR), palladium (PA) and gasoline (GA) futures markets. The automobile industry is responsible for more than 50% of global demand for each of these commodities. VAR estimation reveals short-run cross-market interaction between NR and GA, and from NR to PA. Cross-market influence exerted by PA is felt in longer dynamics, with PA volatility (volume) affecting NR (GA) volume (volatility). Our findings are robust to lag-specification, volatility measure, and consistent with full BEKK-GARCH estimation results. Further analysis, which benchmarks against silver futures market, TOCOM index and TOPIX transportation index, confirms that our results are driven by a common industry exposure, and not a commodity market factor. A simple trading rule that incorporates short-run GA and long-run PA dynamics to predict NR return yields positive economic profit. Our study offers new insights into how commodity and equity markets relate at an industry level, and implications for multi-commodity hedging.     

Tactical allocation in commodity futures markets: Combining momentum and term structure signals

This paper examines the combined role of momentum and term structure signals for the design of profitable trading strategies in commodity futures markets. With significant annualized alphas of 10.14% and 12.66%, respectively, the momentum and term structure strategies appear profitable when implemented individually. With an abnormal return of 21.02%, our double-sort strategy that exploits both momentum and term structure signals clearly outperforms the single-sort strategies. This double-sort strategy can additionally be utilized as a portfolio diversification tool. The abnormal performance of the combined portfolios cannot be explained by a lack of liquidity, data mining or transaction costs.     

Capturing the risk premium of commodity futures: The role of hedging pressure

We construct long–short factor mimicking portfolios that capture the hedging pressure risk premium of commodity futures. We consider single sorts based on the open interests of hedgers or speculators, as well as double sorts based on both positions. The long–short hedging pressure portfolios are priced cross-sectionally and present Sharpe ratios that systematically exceed those of long-only benchmarks. Further tests show that the hedging pressure risk premiums rise with the volatility of commodity futures markets and that the predictive power of hedging pressure over cross-sectional commodity futures returns is different from the previously documented forecasting power of past returns and the slope of the term structure.     

Lessons from the evolution of foreign exchange trading strategies

The adaptive markets hypothesis posits that trading strategies evolve as traders adapt their behavior to changing circumstances. This paper studies the evolution of trading strategies for a hypothetical trader who chooses portfolios from foreign exchange (forex) technical rules in major and emerging markets, the carry trade, and US equities. The results show that a backtesting procedure to choose optimal portfolios improves upon the performance of nonadaptive rules. We also find that forex trading alone dramatically outperforms the S&P 500, with much larger Sharpe ratios over the whole sample, but there is little gain to coordinating forex and equity strategies, which explains why practitioners consider these tools separately. Forex trading returns dip significantly in the 1990s but recover by the end of the decade and have been markedly superior to an equity position since 1998. Overall, trading rule returns still exist in forex markets—with substantial stability in the types of rules—though they have migrated to emerging markets to a considerable degree.     

IQ,trading behavior,and performance

We analyze whether IQ influences trading behavior, performance, and transaction costs. The analysis combines equity return, trade, and limit order book data with two decades of scores from an intelligence (IQ) test administered to nearly every Finnish male of draft age. Controlling for a variety of factors, we find that high-IQ investors are less subject to the disposition effect, more aggressive about tax-loss trading, and more likely to supply liquidity when stocks experience a one-month high. High-IQ investors also exhibit superior market timing, stock-picking skill, and trade execution.     

O/S: The relative trading activity in options and stock

Relatively little is known about the trading volume in derivatives relative to the volume in underlying stocks. We study the time-series properties and the determinants of the options/stock trading volume ratio (O/S) using a comprehensive cross-section and time-series of data on equities and their listed options. O/S is related to many intuitive determinants such as delta and trading costs, and it also varies with institutional holdings, analyst following, and analyst forecast dispersion. O/S is higher around earnings announcements, suggesting increased trading in the options market. Further, post-announcement absolute returns are positively related to pre-announcement O/S, which suggests that at least part of the pre-announcement options trading is informed.     

Pinning in the S&P 500 futures

We show that Standard & Poor's (S&P) 500 futures are pulled toward the at-the-money strike price on days when serial options on the S&P 500 futures expire (pinning) and are pushed away from the cost-of-carry adjusted at-the-money strike price right before the expiration of options on the S&P 500 index (anti-cross-pinning). These effects are driven by the interplay of market makers' rebalancing of delta hedges due to the time decay of those hedges as well as in response to reselling (and early exercise) of in-the-money options by individual investors. The associated shift in notional futures value is at least $115 million per expiration day.     

Asymmetric effect of basis on dynamic futures hedging: Empirical evidence from commodity markets

The dynamic minimum variance hedge ratios (MVHRs) have been commonly estimated using the Bivariate GARCH model that overlooks the basis effect on the time-varying variance–covariance of spot and futures returns. This paper proposes an alternative specification of the BGARCH model in which the effect is incorporated for estimating MVHRs. Empirical investigation in commodity markets suggests that the basis effect is asymmetric, i.e., the positive basis has greater impact than the negative basis on the variance and covariance structure. Both in-sample and out-of-sample comparisons of the MVHR performance reveal that the model with the asymmetric effect provides greater risk reduction than the conventional models, illustrating importance of the asymmetric effect when modeling the joint dynamics of spot and futures returns and hence estimating hedging strategies.     

Option trading and individual investor performance

This paper examines the impact of option trading on individual investor performance. The results show that most investors incur substantial losses on their option investments, which are much larger than the losses from equity trading. We attribute the detrimental impact of option trading on investor performance to poor market timing that results from overreaction to past stock market returns. High trading costs further contribute to the poor returns on option investments. Gambling and entertainment appear to be the most important motivations for trading options while hedging motives only play a minor role. We also provide strong evidence of performance persistence among option traders.     

Insider trading in credit derivatives

Insider trading in the credit derivatives market has become a significant concern for regulators and participants. This paper attempts to quantify the problem. Using news reflected in the stock market as a benchmark for public information, we find significant incremental information revelation in the credit default swap market under circumstances consistent with the use of non-public information by informed banks. The information revelation occurs only for negative credit news and for entities that subsequently experience adverse shocks, and increases with the number of a firm's relationship banks. We find no evidence, however, that the degree of asymmetric information adversely affects prices or liquidity in either the equity or credit markets.     

Informed momentum trading versus uninformed “naive” investors strategies

We construct a zero net-worth uninformed “naive investor” who uses a random portfolio allocation strategy. We then compare the returns of the momentum strategist to the return distribution of naive investors. For this purpose we reward momentum profits relative to the return percentiles of the naive investors with scores that are symmetric around the median. The score function thus constructed is invariant and robust to risk factor models. We find that the average scores of the momentum strategies are close to zero (the score of the median) and statistically insignificant over the sample period between 1926 and 2005, various sub-sample periods including the periods examined in [Jegadeesh and Titman, 1993] and [Jegadeesh and Titman, 2001]. The findings are robust with respect to sampling or period-specific effects, tightened score intervals, and the imposition of maximum-weight restrictions on the naive strategies to mitigate market friction considerations.     

Caught on tape: Institutional trading,stock returns,and earnings announcements

Many questions about institutional trading can only be answered if one tracks high-frequency changes in institutional ownership. In the United States, however, institutions are only required to report their ownership quarterly in 13-F filings. We infer daily institutional trading behavior from the “tape”, the Transactions and Quotes database of the New York Stock Exchange, using a sophisticated method that best predicts quarterly 13-F data from trades of different sizes. We find that daily institutional trades are highly persistent and respond positively to recent daily returns but negatively to longer-term past daily returns. Institutional trades, particularly sells, appear to generate short-term losses—possibly reflecting institutional demand for liquidity—but longer-term profits. One source of these profits is that institutions anticipate both earnings surprises and post-earnings announcement drift. These results are different from those obtained using a standard size cutoff rule for institutional trades.     

The Samuelson hypothesis in futures markets: An analysis using intraday data

This paper considers the Samuelson hypothesis, which argues that the futures price volatility increases as the futures contract approaches its expiration. Utilizing intraday data from 20 futures markets in six futures exchanges, we find strong support for the Samuelson hypothesis in agricultural futures. However, the Samuelson hypothesis does not hold for other futures contracts. We also provide supporting evidence that the ‘negative covariance’ hypothesis is the key factor for the empirical support of the Samuelson hypothesis. In addition, our findings remain largely unaltered even after we control for seasonality and liquidity effects.     

Household portfolio choices,health status and health care systems: A cross-country analysis based on SHARE

Health risk is increasingly viewed as an important form of background risk that affects household portfolio decisions. However, its role might be mediated by the presence of a protective full-coverage national health service that could reduce households’ probability of incurring current and future out-of-pocket medical expenditures. We use SHARE data to study the influence of current health status and future health risk on the decision to hold risky assets, across ten European countries with different health systems, each offering a different degree of protection against out-of-pocket medical expenditures. We find robust empirical evidence that perceived health status matters more than objective health status and, consistent with the theory of background risk, health risk affects portfolio choices only in countries with less protective health care systems. Furthermore, portfolio decisions consistent with background risk models are observed only with respect to middle-aged and highly-educated investors.     

Institutional stock trading on loan market information

One of the most important developments in the corporate loan market over the past decade has been the growing participation of institutional investors. As lenders, institutional investors routinely receive private information about borrowers. However, most of these investors also trade in public securities. This leads to a controversial question: Do institutional investors use private information acquired in the loan market to trade in public securities? This paper examines the stock trading of institutional investors whose portfolios also hold loans. Using the Securities and Exchange Commission filings of loan amendments, we identify institutional investors with access to private information disclosed during loan amendments. We then look at abnormal returns on subsequent stock trades. We find that institutional participants in loan renegotiations subsequently trade in the stock of the same company and outperform trades by other managers and trades in other stocks by approximately 5.4% in annualized terms.     

Momentum strategies based on reward–risk stock selection criteria

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.     

Combining mean reversion and momentum trading strategies in foreign exchange markets

The literature on equity markets documents the existence of mean reversion and momentum phenomena. Researchers in foreign exchange markets find that foreign exchange rates also display behaviors akin to momentum and mean reversion. This paper implements a trading strategy combining mean reversion and momentum in foreign exchange markets. The strategy was originally designed for equity markets, but it also generates abnormal returns when applied to uncovered interest parity deviations for five countries. I find that the pattern for the positions thus created in the foreign exchange markets is qualitatively similar to that found in the equity markets. Quantitatively, this strategy performs better in foreign exchange markets than in equity markets. Also, it outperforms traditional foreign exchange trading strategies, such as carry trades and moving average rules.     

Asset market linkages: Evidence from financial, commodity and real estate assets

We use a general Markov switching model to examine the relationships between returns over three different asset classes: financial assets (US stocks and Treasury bonds), commodities (oil and gold) and real estate assets (US Case-Shiller index). We confirm the existence of two distinct regimes: a “tranquil” regime with periods of economic expansion and a “crisis” regime with periods of economic decline. The tranquil regime is characterized by lower volatility and significantly positive stock returns. During these periods, there is also evidence of a flight from quality - from gold to stocks. By contrast, the crisis regime is characterized by higher volatility and sharply negative stock returns, along with evidence of contagion between stocks, oil and real estate. Furthermore, during these periods, there is strong evidence of a flight to quality - from stocks to Treasury bonds.