Momentum Investing in Commodity Futures - EQUELLA Investing in Commodity Futures John Hua Fan BFin ... 123 Figure 4-2 ... Dr Rakesh Gupta, Dr Bin Li, Dr Suman Neupane, ...

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  • Momentum Investing in Commodity Futures

    John Hua Fan

    BFin (Honours), BCom. Griff

    Department of Accounting, Finance and Economics

    Griffith Business School

    Griffith University

    Submitted in fulfilment of the requirements of the degree of

    Doctor of Philosophy

    In the field of Finance

    January 2014

  • i

    Abstract

    Momentum, the tendency of recent winner stocks to continue to rise and recent

    loser stocks to continue to fall, is one of the most puzzling asset pricing anomalies in

    modern finance. The recent boom in commodity futures investments has sparked

    renewed interest from both academia and industry in momentum investment strategies.

    This thesis proposes and examines the performance of three novel momentum-based

    active investment strategies in commodity futures. Conventional momentum strategies

    rely on 12 months of past returns for the formation of investment portfolios. First, this

    thesis proposes a more granular strategy termed microscopic momentum, which

    decomposes conventional momentum into single-month momentum components. The

    novel decomposition reveals that a microscopic momentum strategy generates

    persistent economic profits even after controlling for sector-specific or month-of-year

    commodity seasonality effects. Furthermore, we find that all 12 months of past returns

    play an important role in determining the conventional momentum profits.

    Second, for the first time in the literature, we document a consistent reversal

    pattern in commodity momentum profits. Combining the observed reversal pattern

    with the momentum signal, the strategy in the second study significantly outperforms

    conventional strategies. The profitability of the proposed strategy cannot be explained

    by standard asset pricing risk factors, market volatility, investors sentiment, data-

    mining or transaction costs, but appears to be related to global funding liquidity.

    Furthermore, the proposed investment strategy in commodity futures may be employed

    as a portfolio diversification tool.

    Third and finally, we examine the performance of the 52-week high momentum

    strategy, constructed using the nearness to the 52-week high. The findings suggest that

    the 52-week high momentum is a better predictor of returns than conventional

    momentum in commodity futures. Unlike the stock market, we show that 52-week

    high momentum profits do reverse in post-formation. The findings suggest that

    conventional momentum profits can be largely explained by investors anchoring

    behaviour around the 52-week high and low price levels. Furthermore, we show that

    global funding liquidity plays a significant role in understanding the 52-week high

    momentum profits in commodity futures.

  • ii

    Statement of Originality

    I hereby declare that this submission is my own work and to the best of my

    knowledge it contains no materials previously published or written by another person,

    or substantial proportions of material which have been accepted for the award of any

    other degree or diploma at Griffith University or any other educational institution,

    except where due acknowledgement is made in the thesis. Any contribution made to

    the research by others, with whom I have worked at Griffith University or elsewhere,

    is explicitly acknowledged in the thesis. I also declare that the intellectual content of

    this thesis is the product of my own work, except to the extent that assistance from

    others in the project's design and conception or in style, presentation and linguistic

    expression is acknowledged.

    Signed:

    John Hua Fan

    23 January 2014

  • iii

    Table of Contents

    Abstract .................................................................................................................. i

    Statement of Originality ........................................................................................ ii

    List of Tables ....................................................................................................... vii

    List of Figures ...................................................................................................... ix

    Acknowledgements ............................................................................................... x

    Chapter 1 Introduction ....................................................................................... 1

    1.1 Overview and Rationale .............................................................................. 1

    1.2 Key Research Questions .............................................................................. 3

    1.3 Research Contribution and Thesis Structure ............................................... 5

    Chapter 2 Literature Review ............................................................................. 9

    2.1 Introduction ................................................................................................. 9

    2.2 Asset Pricing ................................................................................................ 9

    2.2.1 Efficient Market Hypothesis ............................................................... 10

    2.2.2 The Capital Asset Pricing Model ........................................................ 12

    2.2.3 The Arbitrage Pricing Theory ............................................................. 14

    2.2.4 The Rise of Market Anomalies ........................................................... 16

    2.2.5 Behavioural Finance and Adaptive Markets Hypothesis .................... 17

    2.3 Momentum Anomaly ................................................................................. 20

    2.3.1 The Evidence ...................................................................................... 20

    2.3.2 Sources of Momentum Profits ............................................................ 22

    2.3.3 Alternative Explanations ..................................................................... 29

    2.3.4 Other Asset Classes ............................................................................ 35

    2.3.5 Alternative Momentum Strategies ...................................................... 37

  • iv

    2.4 Long-Term Return Reversal ...................................................................... 40

    2.4.1 The Evidence of Return Reversal ....................................................... 41

    2.4.2 Sources of Contrarian Profits .............................................................. 42

    2.5 Commodity Futures ................................................................................... 46

    2.5.1 Commodity Futures as an Investment ................................................ 47

    2.5.2 Expected Return .................................................................................. 48

    2.5.3 Asset Pricing for Commodity Futures ................................................ 51

    2.5.4 Commodities Momentum ................................................................... 55

    2.6 Conclusion and Research Gaps ................................................................. 59

    Chapter 3 Microscopic Momentum ................................................................. 62

    3.1 Introduction ............................................................................................... 62

    3.2 Related Literature ...................................................................................... 64

    3.3 Data and Commodity Portfolio Formation ................................................ 66

    3.4 Empirical Results ....................................................................................... 74

    3.4.1 Conventional Momentum Strategies .................................................. 74

    3.4.2 Echo Momentum ................................................................................. 76

    3.4.3 Microscopic Momentum ..................................................................... 82

    3.4.4 Robustness of Microscopic Momentum ............................................. 91

    3.4.5 Transaction Costs ................................................................................ 93

    3.5 Insights from Microscopic Momentum ..................................................... 93

    3.5.1 Methodology ....................................................................................... 93

    3.5.2 RNM Echo Momentum ...................................................................... 96

    3.5.3 JT Conventional Momentum .............................................................. 98

    3.6 Understanding Microscopic Momentum ................................................... 99

    3.7 Conclusion ............................................................................................... 105

  • v

    Chapter 4 Combining Momentum with Reversal ........................................ 107

    4.1 Introduction ............................................................................................. 107

    4.2 Data .......................................................................................................... 111

    4.3 Momentum Based Single-Sort Strategies ................................................ 115

    4.3.1 Methodology ..................................................................................... 115

    4.3.2 Strategy Performance and Risk Adjustment ..................................... 118

    4.3.3 Momentum Profit Post-formation and the Reversal Signal .............. 121

    4.4 Double-sort Strategies: Improving Momentum with Reversal ............... 126

    4.4.1 Methodology ..................................................................................... 126

    4.4.2 Strategy Performance ........................................................................ 130

    4.4.3 Factor Loadings ................................................................................ 138

    4.4.4 Decomposition of Strategy Returns .................................................. 140

    4.4.5 Data-snooping and Transaction Costs .............................................. 144

    4.4.6 Diversification Benefits .................................................................... 149

    4.5 Conclusion ............................................................................................... 149

    Chapter 5 52-week High and Low Momentum ............................................ 152

    5.1 Introduction ............................................................................................. 152

    5.2 Data and Portfolio Formation .................................................................. 155

    5.3 Empirical Results ..................................................................................... 161

    5.3.1 Profitability of 52-week High and Low Momentum Strategies ....... 161

    5.3.2 Comparing Conventional, 52-week High and Low Momentum ...... 166

    5.3.3 Understanding the 52-week High/Low Momentum ......................... 174

    5.3.4 Sub-period Results and the Adaptive Market Hypothesis ................ 179

    5.4 Conclusion ............................................................................................... 183

  • vi

    Chapter 6 Conclusion ..................................................................................... 185

    6.1 Concluding Remarks ............................................................................... 185

    6.2 Relevance and Implication ...................................................................... 187

    6.3 Limitation and Avenues for Future Research .......................................... 190

    Appendix ........................................................................................................... 193

    References ......................................................................................................... 197

  • vii

    List of Tables

    Table 3-1 Profitability of conventional momentum strategies ..................................... 72

    Table 3-2 Performance statistics of conventional momentum strategies ..................... 73

    Table 3-3 Performance of echo momentum strategies ................................................. 77

    Table 3-4 Performance of microscopic momentum ..................................................... 81

    Table 3-5 Pairwise correlations of microscopic momentum ........................................ 85

    Table 3-6 Regressions of microscopic momentum on echo momentum ...................... 95

    Table 3-7 Regressions of microscopic momentum on conventional momentum ........ 97

    Table 3-8 UMD factor loadings of conventional momentum, echo and microscopic

    momentum .................................................................................................................. 100

    Table 3-9 Fuertes et., al. (2010) factors on conventional, echo and microscopic

    momentum .................................................................................................................. 102

    Table 4-1 Summary statistics ..................................................................................... 114

    Table 4-2 Performance of single-sort momentum strategies ...................................... 117

    Table 4-3 Single-sort momentum and risk adjustment ............................................... 120

    Table 4-4 Performance of double-sort momentum strategies .................................... 129

    Table 4-5 Performance of double-sort momentum strategies (excluding commodity

    sectors) ........................................................................................................................ 135

    Table 4-6 Factor loadings of double-sort momentum strategies ................................ 137

    Table 4-7 Liquidity, volatility, sentiment and extremes ............................................. 139

    Table 4-8 Extreme funding liquidity and decomposed double-sort strategy return ... 143

    Table 4-9 Correlations of single and double sort strategies with asset classes .......... 148

  • viii

    Table 5-1 Commodities data description .................................................................... 156

    Table 5-2 Performance of momentum strategies ........................................................ 160

    Table 5-3 Commodity market sectors and 52-week high/low momentum strategies 163

    Table 5-4 Pairwise comparison of 52-week high/low and conventional momentum

    profits .......................................................................................................................... 167

    Table 5-5 Explanatory power of 52-week high/low momentum ................................ 169

    Table 5-6 Correlations ................................................................................................ 171

    Table 5-7 Risk adjustments ........................................................................................ 175

    Table 5-8 Liquidity, volatility and sentiment extremes .............................................. 177

    Table 5-9 Sub-period results ....................................................................................... 180

  • ix

    List of Figures

    Figure 3-1 Di...