In this article,1 we consider two forms of volatility weighting—own volatility and underlying volatility—applied to cross-sectional and time-series momentum strategies. We present some simple theoretical results for the Sharpe ratios of weighted strategies and show empirical results for momentum strategies applied to US industry portfolios.
We find that both the timing effect and the stabilizing effect of volatility weighting are relevant. We also introduce a dispersion weighting scheme that treats cross-sectional dispersion as (partially) forecastable volatility. Although dispersion weighting improves the Sharpe ratio, it seems to be less effective than volatility weighting.
1Du Plessis, J. and Hallerbach, W. G., 2017, ‘Volatility weighting applied to momentum strategies’, The Journal of Alternative Investments.
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