Quant Mashup - SR SV
Inventory scores and metal futures returns [SR SV]
Inventory scores are quantamental (point-in-time) indicators of the inventory states and dynamics of economies or commodity sectors. Inventory scores plausibly predict base metal futures returns due to two effects. First, they influence the convenience yield of a metal and the discount at which
- 5 months ago, 5 May 2024, 11:00pm -
Macroeconomic data and systematic trading strategies [SR SV]
While economic information undeniably wields a significant and widespread influence on financial markets, the systematic incorporation of macroeconomic data into trading strategies has thus far been limited. This reflects skepticism towards economic theory and serious data problems, such as
- 5 months ago, 22 Apr 2024, 10:26pm -
FX trading signals with regression-based learning [SR SV]
Regression-based statistical learning helps build trading signals from multiple candidate constituents. The method optimizes models and hyperparameters sequentially and produces point-in-time signals for backtesting and live trading. This post applies regression-based learning to macro trading
- 6 months ago, 6 Apr 2024, 06:12pm -
Macro trends and equity allocation: a brief introduction [SR SV]
Macroeconomic trends affect stocks differently, depending on their lines of business and their home markets. Hence, point-in-time macro trend indicators can support two types of investment decisions: allocation across sectors within the same country and allocation across countries within the same
- 6 months ago, 5 Apr 2024, 07:52pm -
Macro trends and equity allocation: a brief introduction [SR SV]
Macroeconomic trends affect stocks differently, depending on their lines of business and their home markets. Hence, point-in-time macro trend indicators can support two types of investment decisions: allocation across sectors within the same country and allocation across countries within the same
- 6 months ago, 24 Mar 2024, 10:27pm -
Regression-based macro trading signals [SR SV]
Regression is one method for combining macro indicators into a single trading signal. Specifically, statistical learning based on regression can optimize model parameters and hyperparameters sequentially and produce signals based on whatever model has predicted returns best up to a point in time.
- 7 months ago, 24 Feb 2024, 08:55pm -
Generic derivative returns and carry (for strategy testing) [SR SV]
Backtesting of macro trading strategies requires good approximate profit-and-loss data for standard derivatives positions, particularly in equity, foreign exchange, and rates markets. Practical calculation methods of generic proxy returns not only deliver valid strategy targets but are also the
- 8 months ago, 11 Feb 2024, 05:14am -
Equity market timing: the value of consumption data [SR SV]
The dividend discount model suggests that stock prices are negatively related to expected real interest rates and positively to earnings growth. The economic position of households or consumers influences both. Consumer strength spurs demand and exerts price pressure, thus pushing up real policy
- 8 months ago, 28 Jan 2024, 02:49am -
Advanced FX carry strategies with valuation adjustment [SR SV]
FX forward-implied carry is a popular ingredient in currency trading strategies because it is related to risk premia and implicit policy subsidies. Its signal value can often be increased by considering inflation differentials, hedging costs, data outliers, and market restrictions. However, even
- 8 months ago, 16 Jan 2024, 09:02pm -
Tracking systematic default risk [SR SV]
Systematic default risk is the probability of a critical share of the corporate sector defaulting simultaneously. It can be analyzed through a corporate default model that accounts for both firm-level and communal macro shocks. Point-in-time estimation of such a risk metric requires accounting data
- 9 months ago, 30 Dec 2023, 03:16am -
Commodity carry as a trading signal – part 2 [SR SV]
Carry on commodity futures contains information on implicit subsidies, such as convenience yields and hedging premia. Its precision as a trading signal improves when incorporating adjustments for inflation, seasonal effects, and volatility. There is strong evidence for the predictive power of
- 10 months ago, 29 Nov 2023, 08:32pm -
Commodity carry as a trading signal – part 1 [SR SV]
Commodity futures carry is the annualized return that would arise if all prices remained unchanged. It reflects storage and funding costs, supply and demand imbalances, convenience yield, and hedging pressure. Convenience and hedging can give rise to an implicit subsidy, i.e., a non-standard risk
- 10 months ago, 20 Nov 2023, 09:41pm -
Sovereign debt sustainability and CDS returns [SR SV]
Selling protection through credit default swaps is akin to writing put options on sovereign default. Together with tenuous market liquidity, this explains the negative skew and heavy fat tails of generic CDS (short protection or long credit) returns. Since default risk depends critically on
- 11 months ago, 6 Nov 2023, 10:20pm -
Macro demand-based rates strategies [SR SV]
The pace of aggregate demand in the macroeconomy exerts pressure on interest rates. In credible inflation targeting regimes, excess demand should be negatively related to duration returns and positively to curve-flattening returns. Indeed, point-in-time market information states of various macro
- 11 months ago, 22 Oct 2023, 11:16pm -
How to measure the quality of a trading signal [SR SV]
The quality of a trading signal depends on its ability to predict future target returns and to generate material economic value when applied to positioning. Statistical metrics of these two properties are related but not identical. Empirical evidence must support both. Moreover, there are
- 1 year ago, 9 Oct 2023, 07:15pm -
The predictive power of real government bond yields [SR SV]
Real government bond yields are indicators of standard market risk premia and implicit subsidies. They can be estimated by subtracting an estimate of inflation expectations from standard yields. And for credible monetary policy regimes, inflation expectations can be estimated based on concurrent
- 1 year ago, 25 Sep 2023, 09:13am -
Equity versus fixed income: the predictive power of bank surveys [SR SV]
Bank lending surveys help predict the relative performance of equity and duration positions. Signals of strengthening credit demand and easing lending conditions favor a stronger economy and expanding leverage, benefiting equity positions. Signs of deteriorating credit demand and tightening credit
- 1 year ago, 9 Sep 2023, 07:16pm -
Business sentiment and commodity future returns [SR SV]
Business sentiment is a key driver of inventory dynamics in global industry and, therefore, a powerful indicator of aggregate demand for industrial commodities. Changes in manufacturing business confidence can be aggregated by industry size across all major economies to give a powerful directional
- 1 year ago, 26 Aug 2023, 05:57pm -
Nowcasting macro trends with machine learning [SR SV]
Nowcasting economic trends can make use of a broad range of machine learning methods. This not only serves the purpose of optimization but also allows replication of past information states of the market and supports realistic backtesting. A practical framework for modern nowcasting is the
- 1 year ago, 13 Aug 2023, 03:09am -
Pure macro FX strategies: the benefits of double diversification [SR SV]
Pure macro(economic) strategies are trading rules that are informed by macroeconomic indicators alone. They are rarer and require greater analytical resources than standard price-based strategies. However, they are also more suitable for pure alpha generation. This post investigates a pure macro
- 1 year ago, 30 Jul 2023, 07:29pm -
A model for bond risk premia and the macroeconomy [SR SV]
An empirical analysis of the U.S. bond market since the 1960s emphasizes occasional abrupt regime changes, as defined by yield levels, curve slopes, and related volatility metrics. An arbitrage-free bond pricing model illustrates that bond risk premia can be decomposed into two types. One is related
- 1 year ago, 16 Jul 2023, 07:36pm -
Merchandise import as predictor of duration returns [SR SV]
Local-currency import growth is a widely underestimated and important indicator of trends in fixed-income markets. Its predictive power reflects its alignment with economic trends that matter for monetary policy: domestic demand, inflation, and effective currency dynamics. Empirical evidence
- 1 year ago, 20 Jun 2023, 02:35am -
Finding (latent) trading factors [SR SV]
Financial markets are looking at a growing and broadening range of correlated time series for the operation of trading strategies. This increases the importance of latent factor models, i.e., methods that condense high-dimensional datasets into a low-dimensional group of factors that retain most of
- 1 year ago, 6 Jun 2023, 10:35pm -
FX trend following and macro headwinds [SR SV]
Trend following can benefit from consideration of macro trends. One reason is that macroeconomic data indicate headwinds (or tailwinds) for the continuation of market price trends. This is particularly obvious in the foreign-exchange space. For example, the positive return trend of a currency is
- 1 year ago, 20 May 2023, 04:57pm -
Macroeconomic cycles and asset class returns [SR SV]
Indicators of growth and inflation cycles are plausible and successful predictors of asset class returns. For proof of concept, we propose a single balanced “cyclical strength score” based on point-in-time quantamental indicators of excess GDP growth, labor market tightening, and excess
- 1 year ago, 6 May 2023, 03:02am -
Terms of trade as FX trading signal [SR SV]
All other things equal, an improvement in a country’s terms of trade, the ratio of export to import prices, translates into increased demand for its currency and a boost for its growth outlook. However, terms of trade are a rather subtle and sporadic influence. Therefore, many market participants
- 1 year ago, 10 Apr 2023, 10:06pm -
Predicting base metal futures returns with economic data [SR SV]
Unlike other derivatives markets, for commodity futures, there is a direct relation between economic activity and demand for the underlying assets. Data on industrial production and inventory build-ups indicate whether recent past demand for industrial commodities has been excessive or repressed.
- 1 year ago, 25 Feb 2023, 05:59pm -
Testing macro trading factors [SR SV]
The recorded history of modern financial markets and macroeconomic developments is limited. Hence, statistical analysis of macro trading factors often relies on panels, sets of time series across different currency areas. However, country experiences are not independent and subject to common
- 1 year ago, 13 Feb 2023, 09:03pm -
Fiscal policy criteria for fixed-income allocation [SR SV]
The fiscal stance of governments can be a powerful force in local fixed-income markets. On its own, an expansionary stance is seen as a headwind for long-duration or government bond positions due to increased debt issuance, greater default or inflation risk, and less need for monetary policy
- 1 year ago, 29 Jan 2023, 08:53pm -
Detecting trends and mean reversion with the Hurst exponent [SR SV]
The Hurst exponent is a statistical measure of long-term memory of time series. The existence and form of such memory are of great interest in financial markets, as financial returns are not generally governed by random walks. The Hurst exponent is a single scalar value that indicates if a time
- 1 year ago, 14 Jan 2023, 10:30am -
Modified and balanced FX carry [SR SV]
There are two simple ways to enhance FX carry strategies with economic information. The first increases or reduces the carry signal depending on whether relevant economic indicators reinforce or contradict its direction. The output can be called “modified carry”. It is a gentle adjustment that
- 1 year ago, 2 Jan 2023, 03:28pm -
Identifying the drivers of the commodity market [SR SV]
Commodity futures returns are correlated across many different raw materials and products. Research has identified various types of factors behind this commonality: [i] macroeconomic changes, [ii] financial market trends, and [iii] shifts in general uncertainty. A new paper proposes to estimate the
- 1 year ago, 28 Nov 2022, 09:15am -
Macro factors of the risk-parity trade [SR SV]
Risk-parity positioning in equity and (fixed income) duration has been a popular and successful investment strategy in past decades. However, part of that success is owed to a supportive macro environment, with accommodative refinancing conditions and slow, disinflationary, or even deflationary
- 1 year ago, 13 Nov 2022, 10:05pm -
Identifying market regimes via asset class correlations [SR SV]
A recent paper suggests identifying financial market regimes through the correlations of asset class returns. The basic idea is to calculate correlation matrixes for sliding time windows and then estimate pairwise similarities. This gives a matrix of similarity across time. One can then perform
- 1 year ago, 29 Oct 2022, 09:05pm -
Jobs growth as trading signal [SR SV]
Employment growth is an important and underestimated macro factor of financial market trends. Since the expansion of jobs relative to the workforce is indicative of changes in slack or tightness in an economy it serves as a predictor of monetary policy and cost pressure. High employment growth is
- 1 year ago, 16 Oct 2022, 10:17am -
Transaction costs and portfolio strategies [SR SV]
Transaction costs are a key consideration for the development of trading strategies; and not just in final profitability checks. Indeed, disregard for trading costs at the design stage leads to excessive reliance on fleeting small-scale characteristics for return predictors. It also skews the
- 2 years ago, 4 Oct 2022, 01:41am -
Crashes in safe asset markets [SR SV]
A new theoretical paper illustrates the logic behind runs and crashes in modern safe asset markets. Safe assets are characterized by stable value and high liquidity. In times of distress “flight for safety” increases demand for these assets, while “dash for cash” increases supply. However,
- 2 years ago, 10 Aug 2022, 10:21am -
Copulas and trading strategies [SR SV]
Reliance on linear correlation coefficients and joint normal distribution of returns in multi-asset trading strategies can be badly misleading. Such conventions often overestimate diversification benefits and underestimate drawdowns in times of market stress. Copulas can describe the joint
- 2 years ago, 22 Jul 2022, 11:27am -
Trend following: combining market and macro information [SR SV]
Classic trend following is based on market prices or returns. Market trends are relatively cheap to produce, popular, and plausibly generate value in the presence of behavioral biases and rational herding. Macro trends track relevant states of the economy based on fundamental data. They are more
- 2 years ago, 11 Jul 2022, 09:38pm -
The power of macro trends in rates markets [SR SV]
Broad macroeconomic trends, such as inflation, economic growth, and credit creation are critical factors of shifts in monetary policy. Above-target trends support monetary tightening. Below-target dynamics give grounds for monetary easing. Yet, markets may not fully anticipate policy shifts that
- 2 years ago, 25 Jun 2022, 11:21am -
Six ways to estimate realized volatility [SR SV]
Asset return volatility is typically calculated as (annualized) standard deviation of returns over a sequence of periods, usually daily from close to close. However, this is neither the only nor necessarily the best method. For exchange-traded contracts, such as equity indices, one can use open,
- 2 years ago, 13 Jun 2022, 10:51am -
Duration volatility risk premia [SR SV]
Duration volatility risk premium means compensation for bearing return volatility risk of an interest rate swap (IRS) contract. It is the scaled difference between swaption-implied and realized volatility of swap rates’ changes. Historically, these premia have been stationary around positive
- 2 years ago, 30 May 2022, 10:54am -
Inflation as equity trading signal [SR SV]
Academic research suggests that high and rising consumer price inflation puts upward pressure on real discount rates and is a headwind for equity market performance. A fresh analysis of 17 international markets since 2000 confirms an ongoing pervasive negative relation between published CPI dynamics
- 2 years ago, 16 May 2022, 08:43pm -
Economic growth and FX forward returns [SR SV]
Economic growth differentials are plausible predictors of foreign exchange return trends because they are related to differences in monetary policy and return on investment. Suitable metrics for testing growth differentials as trading signals must replicate historic information states. Two types of
- 2 years ago, 1 May 2022, 03:40am -
How to use FX carry in trading strategies [SR SV]
FX forward-implied carry is a valid basis for trading strategies because it is related to divergences in monetary and financial conditions. However, nominal carry is a cheap and rough indicator: related PnLs are highly seasonal, sensitive to global equity markets, and prone to large drawdowns.
- 2 years ago, 18 Apr 2022, 10:30am -
Equity convexity and gamma strategies [SR SV]
Equity convexity means that a stock outperforms in times of large upward or downward movements of the broad market: its elasticity to the market return is curved upward. Gamma is a measure of that convexity. All else equal, positive gamma is attractive, as a stock would outperform in market rallies
- 2 years ago, 4 Apr 2022, 11:48pm -
Predicting volatility with neural networks [SR SV]
Predicting realized volatility is critical for trading signals and position calibration. Econometric models, such as GARCH and HAR, forecast future volatility based on past returns in a fairly intuitive and transparent way. However, recurrent neural networks have become a serious competitor. Neural
- 2 years ago, 21 Mar 2022, 10:46am -
How to manage systemic risk in asset management [SR SV]
Systemic crises are rare but critical for long-term performance records. When the financial system fails, good trades become bad trades and many sensible investment strategies incur outsized losses due to deleveraging and liquidation pressure. Managers have two principal sets of tools to address
- 2 years ago, 4 Mar 2022, 10:26am -
How to estimate factor exposure, risk premia, and discount factors [SR SV]
The basic idea behind factor models is that a large range of assets’ returns can be explained by exposure to a small range of factors. Returns reflect factor risk premia and price responses to unexpected changes in the factors. The theoretical basis is arbitrage pricing theory, which suggests that
- 2 years ago, 23 Jan 2022, 10:28am -
Variance risk premia for patient investors [SR SV]
The variance risk premium manifests as a long-term difference between option-implied and expected realized asset price volatility. It compensates investors for taking short volatility risk, which typically comes with a positive correlation with the equity market and occasional outsized drawdowns. A
- 2 years ago, 10 Jan 2022, 12:03pm -