Momentum strategies with the L1 filter

Tung-Lam Dao

Abstract

ABSTRACT

This filter consists of using an L1 penalty condition in order to obtain the filtered signal composed by a set of straight trends or steps. This penalty condition, which determines the number of breaks, is implemented in a constrained least square problem and is represented by a regularization parameter, (lambda), which is estimated by a cross-validation procedure. Financial time series are usually characterized by a long-term trend (called the global trend) and some short-term trends (which are named local trends). A combination of these two timescales can form a simple model describing the process of a global trend process with some mean-reverting properties. Explicit applications to momentum strategies are also discussed in detail with appropriate uses of the trend configurations.