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On the expected performance of market timing strategies

On the expected performance of market timing strategies

14-11-2014 | Research
We derive expressions for the information ratio (IR) that can be expected from directional market-timing strategies. We show that implementing volatility-weighted bet sizes, both in the time series context of a single underlying market and in the cross-section context of multiple markets, increases the expected timing IR.
  • Winfried  Hallerbach
    Winfried
    Hallerbach
    Senior Quantitative Researcher

Speed read

  • We apply the fundamental law of active management to market timing
  • Implementing volatility-weighted bet sizes increases the expected timing IR
  • Results can be used as a reality check benchmark for the actual IR
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In this study,1 we derive expressions for the IR that can be expected from directional market-timing strategies. The results hold as accurate approximations and lift the Fundamental Law of Active Management proposed by Richard Grinold in 1989 to an operational level. In addition, we separate time series-breadth (the timing frequency per strategy) from cross-section breadth (the number of separate markets), because they contribute differently to performance.

We show that implementing volatility-weighted bet sizes, both in the time series context of a single underlying market and in the cross-section context of multiple markets, increases the expected timing IR. These theoretical results can be used as a benchmark for and reality check on the back-tested performance of timing strategies. We confirm the accuracy of this results by simulating timing strategies for equities and fixed income.

1 Hallerbach, W. G., 2014, ‘On the expected performance of market timing strategies’, The Journal of Portfolio Management.

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