Market Timing: Style (Value Versus Growth) and Size Rotation Using the MVX

This paper analyzes the possibility of using MVX (Montreal Exchange – MX Implied Volatility Index)i the implied volatility of the Canadian market as a leading indicator in the design and execution of long-short trading strategy. We consider the sample 1809 daily data from March 20, 2003 to May 28, 2010. Prior studies finds Market Volatility Index (VIX)ii of the Chicago Board Options Exchange a leading indicator of daily market returns and it indicates that market timing may be feasible. We are extending the work done on market timing and timing the return by using the Canadian counterpart, MVX and stocks from the Toronto Stock Exchange (S&P/TSX Composite Index)iii We examined the possibility of two trading strategies for Canadian market: Strategy one is switching between value and growth portfolios. The strategy involves taking a long position in value portfolio and a short position in growth portfolio when volatility increases and vice versa when volatility decreases. Strategy two is switching between stocks of companies with different market capital (size). The strategy involves taking a long position in large portfolio and a short position in small portfolio when volatility increases and when volatility decreases the opposite will be executed. Using similar methods from Copeland and Copeland (1999), we have a slightly different result which is expected since we are using the Canadian financial system instead of the American financial system. The findings from Copeland and Copeland (1999) are that VIX is a valid indicator and positive excess returns in both directions. The value and large cap outperform its peers when volatility increases. When volatility decreases then small-cap and growth stocks outperform their peers. In other words, both trading strategy of rotating between style and size was affective in the American market. The results of our research show that in the Canadian market, MVX is only a good timing indicator for the rotating using style strategy. We didn’t obtain explainable or robust results from the rotating using size strategy.