How Much Information Is Required to Time the Market?

24 Pages Posted: 14 Aug 2018 Last revised: 30 Nov 2020

See all articles by Rongju Zhang

Rongju Zhang

Commonwealth Scientific and Industrial Research Organization (CSIRO); Monash University - Monash Centre for Quantitative Finance and Investment Strategies

Henry LH Wong

Cbus Super Fund

Date Written: December 12, 2018

Abstract

In this article, the authors present an analytical explanation for why it can be difficult to devise a successful market timing strategy. The authors derive formulas to estimate the minimum required information coefficient for a timing strategy to outperform a buy-and-hold market benchmark, both with and without an alpha target. They show that markets with high Sharpe ratios and those that have low volatility are by nature hard to time. They also show that having high market exposure in a market timing strategy is generally beneficial; however, there can be a critical point beyond which additional market exposure makes timing more difficult. The authors extend the model to cover practical considerations such as transaction costs, skewness and fat tails, and market timing with two correlated assets. Finally, they present a case study to illustrate how investors could apply their framework to choose the optimal market exposure in a market timing strategy using the S&P 500.

Keywords: market timing, information coefficient, market exposure, alpha, Sharpe ratio

JEL Classification: G11

Suggested Citation

Zhang, Rongju and Wong, Henry LH, How Much Information Is Required to Time the Market? (December 12, 2018). Available at SSRN: https://ssrn.com/abstract=3222469 or http://dx.doi.org/10.2139/ssrn.3222469

Rongju Zhang (Contact Author)

Commonwealth Scientific and Industrial Research Organization (CSIRO) ( email )

Door 34, Goods Shed, Village Street
Docklands, VIC 3008
Australia
452204105 (Phone)

Monash University - Monash Centre for Quantitative Finance and Investment Strategies ( email )

9 Rainforest Walk
Clayton Campus
Monash University, Victoria 3800
Australia

Henry LH Wong

Cbus Super Fund ( email )

Level 28
2 Lonsdale Street
Melbourne, Victoria 3000
Australia

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