On the side have been working with someone who is looking for long term strategies in the fixed income space. My strategies focus on intra-day trading primarily, but have found the start of a number of very attractive longer term (low frequency) strategies.
In particular, we are building a multi-factor model to predict market movements for Canadian bonds. Alternatively, we are also looking at cointegration models that would be implemented as long/short baskets of securities.
Sometimes the simplest ideas work best. I decided to look at a function of momentum over a period as a predictor of return over the following period. Did not expect to have such strong results. Here is the average return predicted by momentums at various standard deviations from parity:
An alternate graph of this showing standard deviation bands for returns against momentum levels:
There is certainly more work to be done to understand maximum drawdown and optimal money management.
Beyond momentum, we are also looking at building a continuous economic index (much like the Aruoba-Diebold-Scotto Business Conditions Index). This provides a continuous forecast of economic variables based on a stochastic state space model. Will discuss further in the next post.