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Optimal Dynamic Momentum Strategies

Author

Listed:
  • Kai Li

    (Department of Applied Finance, Macquarie University, New South Wales 2109, Australia; Institute of Financial Studies, Southwestern University of Finance and Economics, Chengdu 610074, China)

  • Jun Liu

    (Rady School of Management, University of California San Diego, La Jolla, California 92093)

Abstract

We explicitly solve for the optimal dynamic trading strategy between a riskless asset and a risky asset with momentum. The optimal portfolio weight depends not only on the momentum, as in Merton’s framework, but also on the historical price path; this contrasts with Merton. Because of their path dependence, optimal portfolio weights have a wide distribution for a given level of momentum; for example, investors may short the risky asset if it has rebound price paths but leverage if it has hump-shaped price paths. This effect tends to be the most significant after large price swings. Path dependence is solved with explicit formulas and presented with heuristic statistics.

Suggested Citation

  • Kai Li & Jun Liu, 2022. "Optimal Dynamic Momentum Strategies," Operations Research, INFORMS, vol. 70(4), pages 2054-2068, July.
    • Handle: RePEc:inm:oropre:v:70:y:2022:i:4:p:2054-2068
    DOI: 10.1287/opre.2021.2254
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