Quant Mashup - SR SV
Reinforcement learning and its potential for trading systems [SR SV]
In general, machine learning is a form of artificial intelligence that allows computers to improve the performance of a task through data, without being directly programmed. Reinforcing learning is a specialized application of (deep) machine learning that interacts with the environment and seeks to
- 2 days ago, 16 Sep 2019, 09:49am -
The low-risk effect: evidence and reason [SR SV]
The low-risk effect refers to the empirical finding that within an asset classes higher-beta securities fail to outperform lower-beta securities. As a result, “betting against beta”, i.e. leveraged portfolios of longs in low-risk securities versus shorts in high-risk securities, have been
- 1 week ago, 7 Sep 2019, 01:34pm -
Analyzing global fixed income markets with tensors [SR SV]
Roughly speaking, a tensor is an array (generalization of a matrix) of numbers that transform according to certain rules when the array’s coordinates change. Fixed-income returns across countries can be seen as residing on tensor-like multidimensional data structures. Hence a tensor-valued
- 3 weeks ago, 25 Aug 2019, 01:41am -
The power of R for trading (part 2) [SR SV]
The R environment makes statistical estimation and learning accessible to portfolio management beyond the traditional quant space. Overcoming technicalities and jargon, managers can operate powerful statistical tools by learning a few lines of code and gaining some basic intuition of statistical
- 1 month ago, 17 Aug 2019, 12:21pm -
The power of R for trading (part 1) [SR SV]
R is an object-oriented programming language and work environment for statistical analysis. It is not just for programmers, but for everyone conducting data analysis, including portfolio managers and traders. Even with limited coding skills R outclasses Excel spreadsheets and boosts information
- 1 month ago, 10 Aug 2019, 07:15am -
The relation between value and momentum strategies [SR SV]
Simple value and momentum strategies often end up with opposite market positions. One strategy succeeds when the other fails. There are two plausible reasons for this. First, value investors regularly bet against market trends that appear to ‘have gone too far’ by standard valuation metrics.
- 1 month ago, 22 Jul 2019, 09:22am -
The mighty “long-long” trade [SR SV]
One of the most successful investment strategies since the turn of the century has been the risk-parity “long-long” of combined equity, credit and duration derivatives. In a simple form this trade takes continuous joint equal mark-to-market exposure in equity or credit and duration risk. A
- 2 months ago, 13 Jul 2019, 09:53am -
The rise in risk spreads [SR SV]
A risk spread is a premium for bearing economic risk of an investment, paid over and above the short-term real interest rate. Over the past 30 years, risk spreads in the U.S. have increased significantly and consistently: while real interest rates on ‘safe’ bonds and deposits have collapsed,
- 2 months ago, 8 Jul 2019, 09:41am -
Bad and good beta in FX strategies [SR SV]
Bad beta means market exposure that is expensive to hedge. Good beta is market exposure that is cheap to hedge. Distinguishing between these is crucial for FX trading strategies. The market sensitivity of FX positions can be decomposed into a risk premium beta (‘bad beta’) and a real rate beta
- 2 months ago, 29 Jun 2019, 11:08am -
Natural language processing for financial markets [SR SV]
News and comments are major drivers for asset prices, maybe more so than conventional price and economic data. Yet it is impossible for any financial professional to read and analyse the vast and growing flow of written information. This is becoming the domain of natural language processing; a
- 3 months ago, 15 Jun 2019, 09:05pm -
A theory of hedge fund runs [SR SV]
Hedge funds’ capital structure is vulnerable to market shocks because most of them offer high liquidity to loss-sensitive investors. Moreover, hedge fund managers form expectations about each other based on market prices and investor flows. When industry-wide position liquidations become a
- 3 months ago, 9 Jun 2019, 07:36pm -
U.S. Treasuries: decomposing the yield curve and predicting returns [SR SV]
A new paper proposes to decompose the U.S. government bond yield curve by applying a ‘bootstrapping method’ that resamples observed return differences across maturities. The advantage of this method over the classical principal components approach would be greater robustness to misspecification
- 3 months ago, 27 May 2019, 03:04am -
Systematic trading strategies: fooled by live records [SR SV]
Allocators to systematic strategies usually trust live records far more than backtests. Given the moral hazard issues of backtesting in the financial industry, this is understandable (view post here). Unfortunately, for many systematic strategies live records can be even more misleading. First, the
- 4 months ago, 12 May 2019, 10:58am -
Bayesian Risk Forecasting [SR SV]
Portfolio risk forecasting is subject to great parameter uncertainty, particularly for longer forward horizons. This simply reflects that large drawdowns are observed only rarely, making it hard to estimate their ‘structural’ properties. Bayesian forecasting addresses parameter uncertainty
- 4 months ago, 5 May 2019, 02:33pm -
The implicit subsidies behind simple trading rules [SR SV]
Implicit subsidies are premia paid by large financial markets participants for reasons other than risk-return optimization (view post here). Their estimation requires skill and a strong “quantamental system”. However, implicit subsidies are behind the popularity and temporary success of many
- 4 months ago, 29 Apr 2019, 10:46am -
Survival in the trading factor zoo [SR SV]
The algorithmic strategy business likes quoting academic research to support specific trading factors, particularly in the equity space. Unfortunately, the rules of conventional academic success provide strong incentives for data mining and presenting ‘significant’ results. This greases the
- 5 months ago, 30 Mar 2019, 08:53am -
Signaling systemic risk [SR SV]
Systemic financial crises arise when vulnerable financial systems meet adverse shocks. A systemic risk indicator tracks the vulnerability rather than the shocks (which are the subject of ‘stress indicators’). A systemic risk indicator is by nature slow-moving and should signal elevated
- 5 months ago, 25 Mar 2019, 09:27am -
How to estimate risk in extreme market situations [SR SV]
Estimating portfolio risk in extreme situations means answering two questions: First, has the market entered an extreme state? Second, how are returns likely to be distributed in such an extreme state? There are three different types of models to address these questions statistically. Conventional
- 6 months ago, 18 Mar 2019, 09:20am -
How salience theory explains the mispricing of risk [SR SV]
Salience theory suggests that decision makers exaggerate the probability of extreme events if they are aware of their possibility. This gives rise to subjective probability distributions and undermines conventional rationality. In particular, salience theory explains skewness preference, i.e. the
- 6 months ago, 2 Mar 2019, 09:23pm -
Algorithmic strategies: managing the overfitting bias [SR SV]
The business of algorithmic trading strategies creates incentives for model overfitting and backtest embellishment: researchers must pass Sharpe ratio thresholds for their strategies to be considered, while managers lack interest in realistic simulations of ideas. Overfitting leads to bad investment
- 7 months ago, 17 Feb 2019, 07:58pm -
Understanding dollar cross-currency basis [SR SV]
Covered interest parity is an arbitrage condition that equalizes costs of direct USD funding and of synthetic USD funding through FX swaps. Deviations are called dollar cross-currency basis and have become a common occurrence since the great financial crisis. A negative dollar basis means direct
- 7 months ago, 9 Feb 2019, 02:05pm -
Why herding is the death of momentum [SR SV]
Momentum trading, buying winning assets and selling losing assets, is a most popular trading strategy. It relies on sluggish market adjustment, allowing the trader to follow best-informed investors before the more inert part of the market does. Herding simply means that market participants imitate
- 7 months ago, 2 Feb 2019, 09:26am -
Drawdown control [SR SV]
Containment of drawdowns and optimization of performance ratios for multi-asset portfolios is critical for trading strategies. Alas, short data series or structural changes often render estimates of covariance matrices unreliable. A popular solution is risk-parity with volatility targeting. An
- 7 months ago, 19 Jan 2019, 10:47am -
Liquidity yields and FX [SR SV]
Liquidity yields are convenience yields of financial securities that typically arise from high liquidity, suitability as collateral or preferred regulatory status. New research argues that relative changes in liquidity yields on government bonds across countries have a significant impact on exchange
- 8 months ago, 12 Jan 2019, 09:54am -
The fundamental value trap [SR SV]
Fundamental value seems like a straightforward investment approach. One simply looks for assets that are “cheap” or “expensive” relative to their rationally expected risk-adjusted discounted cash flows. In reality, conscientious estimation of fundamental value gaps is one of the most
- 8 months ago, 7 Jan 2019, 09:51am -
Equity values and credit spreads: the inflation effect [SR SV]
A theoretical paper shows that a downward shift in expected inflation increases equity valuations and credit default risk at the same time. The reason for this is “nominal stickiness”. A slowdown in consumer prices reduces short-term interest rates but does not immediately reduce earnings growth
- 8 months ago, 29 Dec 2018, 09:46am -
The macro information inefficiency of financial markets [SR SV]
There are reason and evidence for financial markets failing to be efficient with respect to macro trends. The main reason is cost: “tradable” economic research is expensive and investment firms will only invest in such research if their fees on expected incremental portfolio returns exceed their
- 8 months ago, 22 Dec 2018, 10:44pm -
Modern backtesting with integrity [SR SV]
Machine learning offers powerful tools for backtesting trading strategies. However, its computational power and convenience can also be corrosive for financial investment due to its tendency to find temporary patterns while data samples for cross validation are limited. Machine learning produces
- 9 months ago, 15 Dec 2018, 10:09am -
Commodity carry [SR SV]
Across assets, carry is defined as return for unchanged prices and is calculated based on the difference between spot and futures prices (view post here). Unlike other markets, commodity futures curves are segmented by obstacles to intertemporal arbitrage. The costlier the storage, the greater is
- 9 months ago, 10 Dec 2018, 09:44am -
Understanding the correlation of equity and bond returns [SR SV]
The correlation of equity and high grade sovereign bond returns is a powerful driver of portfolio construction and the term premia of interest rates. This correlation has turned from positive in the 1970s-1990s to negative in the 2000s-2010s, on the back of similar shifts in the correlation between
- 9 months ago, 1 Dec 2018, 08:39am -
CDS term premia and exchange rates [SR SV]
The term structure of sovereign credit default swaps (CDS) is indicative of country-specific financial shocks, because rising country risk affects short-dated maturities more than longer-dated ones. This feature allows disentangling global and local risk factors in sovereign CDS markets. The latter
- 9 months ago, 25 Nov 2018, 09:21pm -
Realistic volatility risk premia [SR SV]
The volatility risk premium compensates investors for taking volatility risk. Conceptually it is based on the difference between options-implied and expected realized volatility. In equity markets this premium should be positive in the long run and fluctuate overtime depending on the market’s
- 9 months ago, 19 Nov 2018, 08:37am -
How systemic financial risk is measured [SR SV]
Public institutions have developed a wide range of methods to track systemic financial risk. What most of them have in common is reliance on financial market data. This implies that systemic risk indicators typically only show what the market has already priced, in form of correlation, volatility or
- 10 months ago, 10 Nov 2018, 06:00am -
How convenience yields have compressed real interest rates [SR SV]
Real interest rates on ‘safe’ assets such as high-quality government bonds had been stationary around 2% for more than a century until the 1980s. Since then they have witnessed an unprecedented global decline, with most developed markets converging on the U.S. market trend. There is evidence
- 10 months ago, 3 Nov 2018, 09:21am -
Variance term premia [SR SV]
Variance term premia are surcharges on traded volatility that compensate for bearing volatility risk in respect to underlying asset prices over different forward horizons. The premia tend to increase in financial market distress and decrease in market expansions. Variance term premia have
- 10 months ago, 27 Oct 2018, 09:58am -
The predictability of market-wide earnings revisions [SR SV]
Forward earnings yields are a key metric for the valuation of an equity market. Helpfully, I/B/E/S and DataStream publish forward earnings forecasts of analysts on a market-wide index basis. Unfortunately, updates of these data are delayed by multiple lags. This can make them inaccurate and
- 11 months ago, 13 Oct 2018, 05:15am -
Multiple risk-free interest rates [SR SV]
Financial markets produce more than one risk-free interest rate. This is because there are several separate market segments where structured trades replicate such a rate. Differences in remuneration arise for two reasons. First, financial frictions can prevent arbitrage. Second, some risk-free
- 11 months ago, 6 Oct 2018, 05:50am -
How lazy trading explains FX market puzzles [SR SV]
Not all market participants respond to changing conditions instantaneously, not even in the FX market. Private investors in particular can take a long while to adapt to changes in global interest rate conditions and even institutional investors may be constrained by rules and lengthy process. A
- 11 months ago, 30 Sep 2018, 11:59am -
A brief history of quantitative equity strategies [SR SV]
Understanding quantitative equity investments means understanding a significant portion of market positions. Motivated by the apparent failure of the capital asset pricing model and the efficient market hypothesis, a large share of equity investors follows stylized “factors” that are expected to
- 11 months ago, 22 Sep 2018, 06:20am -
Predicting equity volatility with return dispersion [SR SV]
quity return dispersion is measured as the standard deviation of returns across different stocks or portfolios. Unlike volatility it can be measured even for a single relevant period and, thus, can record changing market conditions fast. Academic literature has shown a clear positive relation
- 1 year ago, 15 Sep 2018, 05:29am -
Earnings yields, equity carry and risk premia [SR SV]
Forward earnings yields and equity carry are plausible indicators of risk premia embedded in equity index futures prices. Data for a panel of 25 developed and emerging markets from 2000 to 2018 show that index forward earnings yields have been correlated with market uncertainty across countries and
- 1 year ago, 8 Sep 2018, 08:56am -
Beta herding [SR SV]
Beta herding means convergence of market betas of individual stocks that arises from investors’ biased perceptions. Adverse beta herding denotes the dispersion of such betas that arises from a reversal of the bias. A new paper suggests that overconfidence in predictions of overall market direction
- 1 year ago, 1 Sep 2018, 10:36pm -
Equity index futures returns: lessons of 2000-2018 [SR SV]
The average annualized return of local-currency index futures for 25 international markets has been 6% with a standard deviation of just under 20%. All markets recorded much fatter tails of returns than should be expected for normal distributions. Autocorrelation has predominantly been positive in
- 1 year ago, 18 Aug 2018, 06:12am -
U.S. dollar exchange rate before FOMC decisions [SR SV]
Since the mid-1990s the dollar exchange rate has mostly anticipated the outcome of FOMC meetings: it appreciated in the days before a rate hike and depreciated in the days before a rate cut. This suggests that since fixed income markets usually predict policy rate moves early and correctly their
- 1 year ago, 15 Aug 2018, 11:11pm -
Endogenous market risk [SR SV]
Understanding endogenous market risk (“setback risk”) is critical for timing and risk management of strategic macro trades. Endogenous market risk here means a gap between downside and upside risk to the mark-to-market value that is unrelated to a trade’s fundamental value proposition. Rather
- 1 year ago, 11 Aug 2018, 10:46am -
What variance swaps tell us about risk premia [SR SV]
Variance swaps are over-the-counter derivatives that exchange payments related to future realized price variance against fixed rates. Variance swaps help estimating term structures for variance risk premia, i.e. market premia for hedging against volatility risk based in the difference between
- 1 year ago, 4 Aug 2018, 12:41pm -
The dangerous disregard for fat tails in quantitative finance [SR SV]
The statistical term ‘fat tails’ refers to probability distributions with relatively high probability of extreme outcomes. Fat tails also imply strong influence of extreme observations on expected future risk. Alas, they are a plausible and common feature of financial markets. A summary article
- 1 year ago, 28 Jul 2018, 02:58am -
The importance of volatility of volatility [SR SV]
Options-implied volatility of U.S. equity prices is measured by the volatility index, VIX. Options-implied volatility of volatility is measured by the volatility-of-volatility index, VVIX. Importantly, these two are conceptually and empirically different sources of risk. Hence, there should also be
- 1 year ago, 21 Jul 2018, 08:23am -
Seasonal effects in commodity futures curves [SR SV]
Seasonal fluctuations are evident for many commodity prices. However, their exact size can be quite uncertain. Hence, seasons affect commodity futures curves in two ways. First, they bias the expected futures price of a specific expiry month relative that of other months. Second, their uncertainty
- 1 year ago, 7 Jul 2018, 07:56am -
VIX term structure as a trading signal [SR SV]
The VIX futures curve reflects expectations of future implied volatility of S&P500 index options. The slope of the curve is indicative of expected volatility and uncertainty relative to volatility and uncertainty priced in the market at present. Loosely speaking, a steeply upward sloped VIX
- 1 year ago, 23 Jun 2018, 07:05am -