Modelling Style Rotation: Switching and Re-Switching

Abstract

The paper helps understand some of the properties of asset returns that are caused by momentum-driven investors. The purpose of this paper is to investigate the dynamics and statistics of style rotation based on the Barberis-Shleifer model of style switching based on modelling interaction between two types of traders: momentum traders and fundamental traders. Whilst we do not claim to be able to do this in an empirical sense, we derive a number of closed-form solutions of the Barberis-Shleifer model which allow us to understand some of the time series properties of style relative price performance and determine the statistical properties of the time until a switch between styles. We apply our results to a set of empirical data to get estimates of some of the model parameters including the level of risk aversion of market participants.

Keywords: market dynamics, asset styles, style rotation, momentum

JEL Classification: C22, G12