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Return Chasing and Trend Following: Unveiling Fundamental Differences Beneath Surface Similarities

Last Updated on 10 February, 2024 by Rejaul Karim

Delving into the intricate dance between investor behavior and market dynamics, “Return Chasing and Trend Following: Superficial Similarities Mask Fundamental Differences” by Victor Haghani and Samantha McBride, affiliated with Elm Partners, embarks on a quest to demystify the often-cited phenomenon of return chasing.

Published on January 21, 2016, and revised on January 30, 2016, this paper pioneers a clear and testable definition of return chasing, distinguishing it from trend following—a nuance overlooked in existing literature. Intriguingly, the study unveils how return chasing elucidates the performance gap between active market timing investors and static asset allocation strategies.

It further unravels the intricate connection between return chasing and the positive returns garnered by trend following strategies, shedding light on the profound impact of trading flows on prices. This research, an essential addition to the discourse on momentum, trend following, and investor behavior, provides a fresh perspective on the intricate interplay shaping market anomalies and investor returns.

Abstract Of Paper

Return chasing is often cited as one of the primary behavioral foibles of investors, resulting in sub-par returns. Surprisingly, the literature does not provide a generally accepted and testable description of return chasing. This paper proposes a simple definition. It then describes how return chasing so defined differs from trend following and how return chasing explains the shortfall of the returns of active, market timing investors compared to static asset allocation strategies. Finally, it shows that if the trading flows of return chasers are large enough to impact prices, then return chasing provides a powerful explanation of the positive returns earned by trend following strategies, which alternative descriptions of return chasing, such as it is trend following but with too long of a horizon, do not provide.

Original paper – Download PDF

Here you can download the PDF and original paper of Return Chasing and Trend Following: Superficial Similarities Mask Fundamental Differences.

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Author

Victor Haghani
Elm Partners

Samantha McBride
Elm Partners

Conclusion

In conclusion, this study unravels the intricate distinctions between return chasing and trend following, dispelling the notion of their superficial similarities. By proposing a precise definition of return chasing, the paper unveils its role in explaining the underperformance of active, market-timing investors compared to static asset allocation strategies.

The findings underscore that return chasing, when influencing trading flows to impact prices significantly, becomes a compelling factor behind the positive returns observed in trend following strategies.

This sheds light on the nuanced dynamics of investor behavior, challenging previous assumptions and providing a more comprehensive understanding of market anomalies, capital flows, and the intricate interplay between sentiment, strategy, and returns.

Related Reading:

Uncovering Trend Rules

Trend-Following Strategies for Tail-Risk Hedging and Alpha Generation

FAQ

Q1: What is the key focus of the paper, “Return Chasing and Trend Following,” and how does it differentiate between return chasing and trend following?

The paper primarily focuses on unraveling the distinctions between return chasing and trend following, dispelling the notion of their superficial similarities. It proposes a precise definition of return chasing and delineates how it differs fundamentally from trend following. By providing clear definitions, the study enhances our understanding of the unique characteristics of each strategy.

Q2: How does the paper explain the impact of return chasing on the underperformance of active, market-timing investors compared to static asset allocation strategies?

The study demonstrates that return chasing, as precisely defined, plays a crucial role in explaining the underperformance of active, market-timing investors when contrasted with static asset allocation strategies. By identifying and understanding the characteristics of return chasing, the paper sheds light on why certain strategies may fall short and how investor behavior influences overall performance.

Q3: What insight does the paper offer regarding the positive returns observed in trend following strategies, and how does it contribute to our understanding of market anomalies and capital flows?

The paper suggests that return chasing, particularly when it significantly impacts trading flows to influence prices, provides a compelling explanation for the positive returns observed in trend following strategies. This insight challenges previous assumptions and contributes to a more comprehensive understanding of market anomalies, capital flows, and the intricate interplay between investor sentiment, strategy implementation, and overall returns in financial markets.

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