EAA Elasticity Score: Correlation-Adjusted Momentum Ranking

The elasticity score is a multi-dimensional ranking metric developed by Wouter Keller and Adam Butler for their Elastic Asset Allocation research (SSRN #2543979). Unlike simple momentum rankings that evaluate assets solely by their trailing returns, the elasticity score incorporates correlation information to penalize assets that move in lockstep with other candidates. The result is a ranking that favors assets combining strong momentum with genuine diversification value — selecting positions that contribute both return and risk reduction to the portfolio.

How It Works

Each asset receives an elasticity score calculated by combining its trailing return with a diversification adjustment derived from its average correlation with all other assets in the universe. The exact formula varies between offensive and defensive variants:

Offensive: z = (1 - Corr) × R² — squares the return to amplify momentum differentiation, multiplied by a diversification factor that approaches zero as correlation approaches one.

Defensive: z = sqrt((1 - Corr) × R) — takes the square root to compress score differentials, producing more balanced allocation weights.

The multiplicative structure is critical: an asset must score well on both dimensions. High return with high correlation produces a modest score. Low return with low correlation also produces a modest score. Only assets with both strong returns and genuine diversification value rank highly.

Why Correlation Matters for Ranking

Standard momentum strategies can concentrate the portfolio in a cluster of highly correlated assets — multiple equity ETFs that are all rising together during a bull market. This cluster looks diversified by name (US, international, emerging markets) but behaves as a single bet during stress events when correlations spike. The elasticity score's correlation penalty steers the ranking away from these false-diversification clusters, preferring assets that provide genuine independence.

Strategies That Use the Elasticity Score

• EAA-OFF — offensive formula with score-proportional weighting
• EAA-DEF — defensive formula with compressed score-proportional weighting
• EAA-LEG-OFF — offensive elasticity merged with PAA breadth protection
• EAA-LEG-DEF — defensive elasticity merged with PAA breadth protection

Score-Proportional vs Equal Weighting

A key feature of the elasticity approach is that portfolio weights are proportional to scores rather than equal. An asset with twice the elasticity score receives twice the allocation. This allows the portfolio to express conviction — heavily weighting the most attractive risk-return combination — while the correlation adjustment ensures that "most attractive" incorporates diversification value, not just raw momentum. The offensive variant produces more concentrated portfolios; the defensive variant produces more balanced ones.