On the Expected Performance of Market Timing Strategies
The Journal of Portfolio Management Summer 2014, Vol. 40, No. 4: pp. 42-51
Posted: 16 Jul 2011 Last revised: 23 Aug 2014
Date Written: July 15, 2011
Abstract
We derive expressions for the Information Ratio (IR) that can be expected from directional market timing strategies. Our results hold as accurate approximations and lift Grinold’s [1989] “Fundamental Law of Active Management” 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. Our 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 our results by simulating timing strategies for equities and fixed income.
Keywords: risk-adjusted performance, information ratio, market timing, volatility-weighting
JEL Classification: C13, C14, C52, G11
Suggested Citation: Suggested Citation