No. of Recommendations: 5
Clarified - and very helpful in developing a leverage strategy!
Looking back at your initial post - it sounds like you're following the same path of interest I took a couple years ago, inspired by Jim's findings.
In that case, I highly recommend running a backtest of the approach you have in mind as I did (e.g., applying leverage at whichever cut-offs you have in mind and removing it at others).
I've found in the past that translating bucket of return type of data like this into a trading strategy with cut-offs does not always produce the slam dunk results one might intuitively assume.
I found that to be true in this case. When I backtested a few years ago, the best I recall seeing was a ~1% CAGR advantage, but it also seemed quite fragile (e.g., adjusting the thresholds up or down a bit wiped that advantage out).
I can't confidently say I know why that strategy produced such a small advantage given the incredibly smooth fall/rise in the P/B bucket forward returns in the table, but I suspect it's related to the data in the buckets not being independent observations as Jim said.
However, if you (or Jim) have found otherwise from your testing (i.e., a mechanical strategy that produced a larger advantage), I'd love to hear it! I'd be thrilled to learn that I made a mistake or that there's some nuance I missed.
