Optimal Dynamic Momentum Strategies

Abstract

Path Dependence of Optimal Dynamic Momentum Strategies The momentum effect has been studied by a tremendous number of papers, but surprisingly, there is little research on optimal momentum strategies. In “Optimal Dynamic Momentum Strategies,” Li and Liu explicitly solve the optimal dynamic portfolio problem when a risky asset has momentum. They show that, to optimally exploit momentum, one needs to account for path dependence, as well as momentum. In contrast, the momentum strategies discussed in most papers exploit only momentum. The optimal portfolio weight also significantly differs from that in the classic framework of Merton. Due to 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 described through explicit formulas as well as heuristic statistics.