Quant Mashup - Alpha Architect Social Networks and Markets: What's the connection? [Alpha Architect]What are the Research Questions? Communication in social networks is not new. In fact, it goes back to coffee houses in the 17th century. According to Standage (2006), “the drama of the South Sea Bubble, a fraudulent investment scheme that collapsed in September 1720, ruining thousands of(...) The Quality Factor: can Intangible Intensity improve it? [Alpha Architect]In our book “Your Complete Guide to Factor-Based Investing,” Andrew Berkin and I provided evidence that among the hundreds of equity factors identified in the literature, there were only five that met our criteria for investment. The factor must have provided a premium that was: persistent(...) Information Decay: which factors have the longest half-lives? [Alpha Architect]What are the research questions? The authors argue that factor exposures are random variables governed by a specific distribution that drives the behavior factor exposures over time. Five factors are examined including value, momentum, quality, investment and low volatility, over 12 developed and(...) Trend-Following Filters – Part 6 [Alpha Architect]This article analyzes six trend-following indicators from a digital signal processing (DSP) frequency domain perspective in which the indicators are considered as digital filters and their frequency response characteristics are determined. In addition, potential trading signals generated by each(...) Informational Efficiency of Stock Prices and Index Investing [Alpha Architect]The authors ask the following questions: Does the rise of index investing change information production in the economy? Does it affect the informational efficiency of stock prices? What are the Academic Insights? The authors augment (and improve) the Grossman and Stiglitz (1980) model of endogenous(...) Combining Reversals with Time-Series Momentum Strategies [Alpha Architect]The empirical evidence from studies such as the 2017 paper “A Century of Evidence on Trend-Following Investing” and the 2020 paper “Time Series Momentum in the US Stock Market: Empirical Evidence and Theoretical Analysis” has found that time-series momentum (TSMOM) has demonstrated(...) Wes Discusses Value Investing Foundations with Isaiah Douglass [Alpha Architect]Here is a link to our recent chat with Isaiah Douglass and Josh Bennett. An overview of the conversation is below: On this week’s episode, Isaiah is joined by expert Dr. Wesley Gray, CEO of Alpha Architect, to discuss the concepts of value The FTX collapse: how did it impact traditional assets? [Alpha Architect]This article deals with the degree of market vulnerability to spillovers from disruptions in the cryptocurrency markets. This study investigates the impact of the FTX collapse and bankruptcy across global financial markets. What do responses of financial markets to the collapse of FTX say about(...) Is a Naive 1/N Diversification Strategy Efficient? [Alpha Architect]Investment strategy should be based on three fundamental principles. First, markets are highly, though not perfectly, efficient. That leads to the conclusion that active management is the loser’s game. Second, if markets are efficient, it must follow that you should believe that all unique sources(...) R & D, Expected Profitability, and Expected Returns [Alpha Architect]Since the development of the CAPM, academic research has attempted to find models that increase the explanatory power of the cross-section of stock returns. We moved from the single-factor CAPM (market beta) to the three-factor Fama-French model (adding size and value), to the Carhart four-factor(...) Salience Theory: How does it impact Momentum Profit? [Alpha Architect]This research examines the potential of enhancing a standard momentum strategy using signals derived from Salience Theory (ST). The strategy presented here is to exclude stocks with extreme salience scores and then analyze the risk and return properties of the ST strategy. Salience theory and(...) Intangibles and the Value Factor [Alpha Architect]Traditional value strategies use common valuation metrics, such as book-to-market (B/M), price-to-earnings (P/E), price-to-sales (P/S) or price-to-cash flow (P/CF), to establish a ratio between a market value and a fundamental anchor to assess the cheapness of a stock. The largest historical(...) International diversification - does it work (when you need it)? [Alpha Architect]In this article, the authors examine the research on the benefits of international diversification. Some argue that because equity markets generally crash simultaneously, there are no benefits to having equity diversification. The evidence from this paper rejects this hypothesis. Diversification(...) Inside the Minds of Expected Stock Returns [Alpha Architect]Financial literature has produced a long list of firm characteristics (referred to as factors) that provide information as to future stock returns, with the explanation for the casual relationship between the characteristics and returns being either risk- or behavioral-based. The traditional finance(...) A Dark Winter for Value Stocks [Alpha Architect]As seen in the table below, the four-year period November 2016-October 2020 could be described as a “dark winter” for value stocks. U.S. value stocks underperformed U.S. growth stocks by 16.81 percentage points per annum (20.35% vs. 3.54%), the largest historical drawdown for value stocks in the(...) Valuation spreads: what they tell us about future expected returns [Alpha Architect]As Cliff Asness demonstrated in his 2012 paper “An Old Friend: The Stock Market’s Shiller P/E,” valuations provide quite a bit of important information for investors. What do valuation spreads tell us about future expected returns? Higher starting values mean that not only are future expected(...) Does dividend impact matter to stock returns? [Alpha Architect]Many investors, especially those using a cash flow approach to spending, have long known that they prefer cash dividends. From the perspective of classical financial theory, this behavior is an anomaly. In their 1961 paper, “Dividend Policy, Growth, and the Valuation of Shares,” Merton Miller(...) Political beta: what does portfolio theory tell us? [Alpha Architect]Using portfolio theory, the authors of this piece develop an approach for estimating the degree of political risk between a country and its export destination and the status of political relationships. The research about political beta presented is the first to apply portfolio theory to problems(...) Mitigating Risks with Factor Strategies [Alpha Architect]The year 2022 was a difficult one for investors in traditional 60/40 portfolios, as equities all around the globe and bonds produced double-digit losses, a very rare event. Can factor strategies mitigate risk? That performance has heightened interest in the diversification benefits of factor-based(...) Expected Returns for Private Equity Will Probably Suck [Alpha Architect]This article attempts to demystify the approach and methodology used to characterize the risk and return relationship in private equity today. The illiquid nature of the asset class makes the demystification of private equity returns difficult to achieve under any circumstances. Still, the framework(...) The Value Factor and Deleveraging [Alpha Architect]In his 2011 presidential address to the American Finance Association, John Cochrane coined the term “zoo of factors,” reflecting concerns about the quality of financial research. How do you separate the signal from the noise? In our book “Your Complete Guide to Factor-Based Investing,”(...) Optimal Trend Following with Transaction Costs [Alpha Architect]Despite the widespread popularity of trend-following investing, little is known about optimal trend-following with transaction costs. A few existing studies consider this question using a continuous-time model within the stochastic optimal control theory framework. However, despite being(...) Asset pricing theory & the role labor displacement plays [Alpha Architect]In this article about asset pricing theory, we examine the research on the impact of technological advances that displace human labor in favor of machine capital to asset pricing. Automation and the displacement of labor by capita: Asset pricing theory and empirical evidence Jiˇrí Knesl Journal of(...) Expected Returns to Green Stocks [Alpha Architect]The past decade has seen a dramatic growth in sustainable investing—applying environmental, social and governance (ESG) criteria to investment strategies. Investments considered environmentally friendly are often referred to as “green,” while “brown” denotes the opposite. Important(...) Geopolitical risk: novel econometric methods! [Alpha Architect]Traditional measures of geopolitical risk have been primarily qualitative. In this article, the authors describe and analyze not just new, but novel measures including textual analysis of news and expert reports, novel econometric methods and machine learning applications for measuring geopolitical(...) Multi-Factor Long-Short Portfolios – how have they performed? [Alpha Architect]Multi-factor, long-short portfolios have provided significant portfolio diversification benefits by adding unique sources of risks that have historically produced premiums that meet the criteria Andrew Berkin and I established in our book “Your Complete Guide to Factor-Based Investing”—the(...) Scale in Active Management - a look at its Diseconomies [Alpha Architect]Pastor, Stambaugh, and Taylor (2015) and Zhu (2018) provide significant evidence of decreasing returns to scale (DRS) at both the fund and industry levels. The authors examine the robustness of their inferences after Adams, Hayunga, and Mansi (2021) critique the above two studies. What are the(...) Machine Learning and Emerging Market Stock Returns [Alpha Architect]More specifically, the paper differentiates between: Traditional linear models (ordinary least squares regression and elastic net) and Machine learning methods that allow for non-linearities and interactions (tree-based models such gradient boosted regression trees and random forest and neural(...) Volatility scaling: is it useful for factor timing? [Alpha Architect]The research summarized here is built upon a documented risk management strategy applied to factor investing (Barroso and Santa-Clara, 2015; Moreira and Muir, 2017). The idea was to overlay a scaled volatility measure designed to change risk exposures and hopefully produce higher Sharpe ratios. That(...) The Size Effect: Does it vary in accordance with monetary policy? [Alpha Architect]The size effect was first documented by Rolf Banz in his 1981 paper “The Relationship Between Return and Market Value of Common Stocks,” which was published in the Journal of Financial Economics. After the 1992 publication of Eugene Fama and Kenneth French’s paper “The Cross-Section of(...) Investing in Deflation, Inflation, and Stagflation Regimes [Alpha Architect]Spikes in inflation and fear of stagflation prompted this study which answers the following question: 1. How do risk premiums and investment strategies behave across inflationary regimes like periods of high inflation, deflation, or stagflation? What are the Academic Insights? By utilizing the(...) Trend Following and Relative Sentiment: Complementary Factors [Alpha Architect]Trend following (time series momentum) is one of the most well-documented and well-known factors in investing, demonstrating persistence, pervasiveness, robustness, and implementability (survives transaction costs). Lesser well-known is relative sentiment—an indicator that measures the positions,(...) Option Momentum: does it work? [Alpha Architect]Several studies show momentum works in global equities, corporate bonds, currencies, and commodities. This paper asks the following research question: Does momentum work within option markets? What are the Academic Insights? By focusing on the returns of delta-neutral straddles (from 1996 to 2019)(...) Trend-Following Rules in Two-State Regime-Switching Models [Alpha Architect]Academic research on trend-following investing has almost exclusively been focused on testing the profitability of various trading rules. Most of these rules are based on moving averages of past prices. The most popular is the Simple Moving Average (SMA). Less commonly used types of moving averages(...) Active manager bias – is it the same as for individual investors? [Alpha Architect]The empirical research on the ability of actively managed funds, including such studies as the 2002 paper “Mutual Fund Performance: An Empirical Decomposition into Stock-Picking Talent, Style, Transactions Costs, and Expenses” by Russ Wermers, has found that they do have the ability to identify(...) Industry and factor momentum: is there a theoretical foundation? [Alpha Architect]This post is the second and final portion of the review on momentum published on Momentum literature. The seminal article on momentum was published by Jegadeesh and Titman in 1993. Although the Jegadeesh article foreshadowed much of the research on cross-sectional and time series momentum at the(...) The decline in interest rates: its role in asset pricing anomalies [Alpha Architect]At its most basic level, factor-based investing is simply about defining, and then systematically following, a set of rules that produce diversified portfolios. An example of factor-based investing is a value strategy, buying cheap (low valuation) assets and selling expensive (high valuation)(...) The Cross Section of Stock Returns Pre CRSP data [Alpha Architect]What are the Research Questions? Several studies reveal variables that predict cross-sectional differences in stock returns but mainly rely on a sample of U.S. stocks, mostly covering the post-1963 period. These studies are often criticized for potential data mining issues since the database never(...) Market Risk and Speculative Factors [Alpha Architect]There are basically two types of investors, those that are risk averse and, thus, both demand risk premiums for taking risk and diversify their holdings, and those who are risk seekers who have a preference for positively skewed (lottery-like) returns which leads them to speculate and concentrate(...) Momentum literature: an analysis of 30 years [Alpha Architect]n this article, the author examines the research published over the last 30 years on momentum and its theoretical credibility. One of the original momentum articles was published by Jegadeesh and Titman in 1993, and is considered the seminal work on the topic. The research review contained in this(...) Momentum Gap - its role in reducing crashes [Alpha Architect]This article discusses the academic research about the Momentum Gap and the role that its predictive potential may have in reducing momentum crashes, hence possibly improving performance. In our book “Your Complete Guide to Factor-Based Investing,” Andrew Berkin and I presented the evidence(...) Asynchronous Trading Revisited: Practical Implications [Alpha Architect]In this article, the author examines several important questions related to asynchronous trading, or the variation in trading frequency that occurs when trading stocks or other assets. Timo Wiedemann, University of Muenster (Germany) The newest version of the paper can be found here. What are the(...) The Effect of Indexing on Price Discovery and Limits to Arbitrage [Alpha Architect]The rise of stock indexing has raised concerns that index investing distorts stock prices—indexers are free riders who rely on prices without contributing to price discovery, thus reducing price efficiency. Byung Ahn and Panos Patatoukas, authors of the study “Identifying the Effect of Stock(...) Democracy: is it better for the stock market? [Alpha Architect]In this article, we examine the research that addresses the question of whether or not democracy leads to better possible outcomes for the stock market. Democracy and Stock Returns Xun Lei and Tomasz Piotr Wisniewski SSRN Working Paper A version of this paper can be found here Want to read our(...) Lottery Demand and the Asset Growth Anomaly [Alpha Architect]It is well documented in the literature that over the long term, low-investment firms have outperformed high-investment firms—with the negative relation between asset growth (AG) and future stock returns particularly featured by the overvaluation of high AG stocks. This finding has led to the(...) Momentum Everywhere, Including Emerging Markets [Alpha Architect]In order for investors to determine which of the hundreds of factors in what John Cochrane famously called the “zoo of factors” were worthy of investment, Andrew Berkin and I set out seven criteria in our book “Your Complete Guide to Factor-based Investing.” For a factor to be considered, it(...) Consumer Spending Data and the Cross-Section of Stock Returns [Alpha Architect]Consumer demand drives the cash flows of consumer-oriented companies. Thus, they should serve as a reliable source of information to predict future fundamentals above and beyond the information contained in financial statements and readily available market data. For example, Jiekun Huang, author of(...) Should Levered and Inverse ETFs Even Exist? [Alpha Architect]In 2019, the SEC proposed that all brokers and advisors be required to determine whether or not their clients understood the risks of investing in levered and inverse exchange traded products before selling such products to them. The SEC moved on this requirement in response to a series of fund(...) Has the Stock Market Systematically Changed? [Alpha Architect]The past few years in the stock market have been pretty crazy. And the pinnacle of “crazy” was during March 2020 — peak chaos in the stock market. Below is a chart of US large-cap stocks and small-cap stocks in 2020. Note the monster crash in March — watch out below! Source: koyfin.com As an(...) How Did Momentum Investing Perform After the Previous Two Valuation Peaks? [Alpha Architect]Near the end of 2021, I wrote an article noting that value portfolios looked historically cheap based on valuation spreads. I found that in the next five years (after the peak), Value investing performed quite well.(1) Following this post, I have received numerous questions related to the following(...)