Correlation-Based Allocation Review

Correlation-Based Allocation Review

January 22, 2013 Value Investing Research
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(Last Updated On: May 9, 2014)

Sanz Prophet has a very detailed and interesting review of an idea we proposed recently: Correlation-Based Allocation.

We propose a model that is designed to identify bull-market and bear-market regimes. We examine correlation between stocks and bonds as a signal. Our hypothesis is that negative correlation between long bonds and stocks represents a bear-market regime, and a positive, or non-existent correlation, reflects a bull market regime.

Correlation-Based Allocation (CBA) is a one-signal model that is simple-to-implement, robust, and historically generates a favorable risk/reward return profile.

As tested, the performance looked pretty good:

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The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Sanz Prophet takes the CBA analysis to another level and conducts a thorough data-mining exercise to determine the optimal way of implementing CBA. Amazing and simultaneously humbling work–wish I had these skills!

http://sanzprophet.blogspot.tw/2013/01/cba-quick-test-drive.html

Here is a quick shot from the website’s analysis:

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I’ll be adding Sanz Prophet to my RSS and added them onto our blogroll.


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Definitions of common statistics used in our analysis are available here (towards the bottom)




About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.