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

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,

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

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

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

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,

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

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

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

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.

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

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

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

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

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

Market regimes are clusters of persistent market conditions. They affect the relevance of investment factors and the success of trading strategies. The practical challenge is to detect market regime changes quickly and to backtest methods that may do the job. Machine learning offers a range of

The risk reversal premium manifests as an overpricing of out-of-the-money put options relative to out-of-the-money call options with equal expiration dates. The premium apparently arises from equity investors’ demand for downside protection, while most market participants are prohibited from

Volatility indices, based upon the methodology of the Cboe volatility index (VIX), serve as measures of near-term market uncertainty across asset classes. They are constructed from out-of-the-money put and call premia using variance swap pricing. Volatility indices for fixed income markets are of

Value opportunities arise when market prices deviate from contracts’ present values of all associated entitlements or obligations. However, this theoretical concept is difficult and expensive to apply. Instead, simple valuation ratios, such as real interest rates or equity earnings yields with

Standard performance statistics are insufficient and potentially misleading for evaluating algorithmic trading strategies. Metrics based on prediction errors mistakenly assume that all errors matter equally. Metrics based on classification accuracy disregard the magnitudes of errors. And traditional

Nowcasting in financial markets is mainly about forecasting forthcoming data reports, particularly GDP releases. However, nowcasting models are more versatile and can be used for a range of market-relevant information, including inflation, sentiment, weather, and harvest conditions. Nowcasting is

Unlike market price trends, macroeconomic trends are hard to track in real-time. Conventional econometric models are immutable and not backtestable for algorithmic trading. That is because they are built with hindsight and do not aim to replicate perceived economic trends of the past (even if their

Dimension reduction methods of machine learning are suited for detecting latent factors of a broad set of asset prices. These factors can then be used to improve estimates of the covariance structure of price changes and – by extension – to improve the construction of a well-diversified minimum

Corporate balance sheet data are important building blocks of quantitative-fundamental (“quantamental”) investment factors. However, accounting terms are easily misunderstood and confused with economic concepts. Accounting is as much driven by assessment of risk as it is by economic value. For

Risk parity is a portfolio construction technique that seeks to equalize risk contributions from the different components of the portfolio. Risk parity with respect to uncorrelated risk sources maximizes diversification. Simple risk parity rules are based on the inverses of market beta, price

A new proxy formula for equity market-to-book ratios suggests that (the logarithm of) such a ratio is equal to the discounted expected value of (i) differences between return on equity and market returns and (ii) the net value added from share issuance or repurchases. A firm with a higher

Empirical evidence suggests that investors pay less attention to macroeconomic news when market sentiment is positive. Market responses to economic data surprises have historically been muted in high sentiment periods. Behavioral research supports the idea that investors prefer heuristic

Standard equity factors are autocorrelated. Hence, it is not surprising that factor strategies have also displayed momentum: past returns have historically predicted future returns. Indeed, factor momentum seems to explain all return momentum in individual stocks and across industries. Momentum has

Since the late 1990s, the negative price correlation of equity and high-grade bonds has reduced the volatility of balanced portfolios and boosted Sharpe ratios of leveraged “long-long” equity-bond strategies. However, this correlation is not structurally stable. Over the past 150 years,

Financial markets are not macro information efficient. This means that investment decisions miss out on ample relevant macroeconomic data and facts. Information goes to waste due to research costs, trading restrictions, and external effects. Evidence of macro information inefficiency includes

Any asset can use a portfolio of similar assets to hedge against its factor exposure. The factor residual risk of the hedged position is called statistical arbitrage risk. Consequently, the statistical arbitrage risk premium is the expected return of such a hedged position. A recent paper shows that

A new Fed paper explains how to construct a real-time distress index, using the case of the corporate bond market. The index is based on metrics that describe the functioning of primary and secondary markets and, unlike other distress measures, does not rely on prices and volatility alone. Thus, it

Investors have a tendency to sell assets that have earned them positive returns and are reluctant to let go of those that have brought them losses. This behavioural bias is called “disposition effect” and is attributed to loss aversion and regret avoidance. It has been widely documented by

Contagion and self-fulfilling feedback loops are propagation mechanisms at the heart of systemic financial crises. Contagion refers to the deterioration of fundamentals through the financial network, often through a cascade of insolvencies. A critical factor is the similarity of assets held by

Market volatility measures the size of variations of asset returns. Macroeconomic uncertainty measures the size of unpredictable disturbances in economic activity. Large moves in macroeconomic uncertainty are less frequent and more persistent than shifts in market volatility. However, macroeconomic

Typically, we cannot predict a meaningful portion of daily or higher-frequency market returns. A more realistic approach is classifying the state of the market for a particular day or hour. A powerful tool for this purpose is artificial neural networks. This is a popular machine learning method that

The purpose of seasonal adjustment is to remove seasonal and calendar effects from economic time series. It is a common procedure but also a complex one, with side effects. Seasonal adjustment has two essential stages. The first accounts for deterministic effects by means of regression and selects a

Theory and plausibility suggest that precious metal prices benefit from inflation and negative real interest rates. This makes gold, silver, platinum, and palladium natural candidates for hedges against inflationary monetary policy. Long-term empirical evidence supports the inflation-precious metal

Survey data and asset prices can be combined to estimate high-frequency growth expectations. This is a specific form of nowcasting that implicitly captures all types of news on the economy, not just official data releases. Methods for estimation include the Kalman filter, MIDAS regression, and

There is a simple method of approximating trend follower positioning in real-time and without lag. It is based on normalized returns in liquid futures markets over plausible lookback windows, under consideration of a leverage constraint, and uses estimated assets under management as a scale factor.

Recent academic papers illustrate how macroeconomic data support predictions of energy market flows and prices. Valid macro indicators include shipping costs, industrial production measures, non-energy industrial commodity prices, transportation data, weather data, financial conditions indices, and

Fundamental trend following uses moving averages of past fundamental data, such as valuation metrics or economic indicators, to predict future fundamentals, analogously to the conventions in price or return trend following. A recent paper shows that fundamental trend following can be applied to

Prospect theory value is a valid investment factor, particularly in episodes of apparent market inefficiency. Prospect theory is a popular model of irrational decision making. It emphasizes a realistic mental representation of expected gains and losses and an individual’s evaluation of such

The tidyverse is a collection of packages that facilitate data science with R. It is particularly powerful for macro trading research because [a] it supports efficient and standardized work with R’s vast universe of econometric models, [b] is well adapted for analyzing data vintages (i.e. data

Nowcasting macro-financial indicators requires combining low-frequency and high-frequency time series. Mixed data sampling (MIDAS) regressions explain a low-frequency variable based on high-frequency variables and their lags. For instance, the dependent variable could be quarterly GDP and the

Combinations of equity returns and yield-curve changes can be used to classify market-implied underlying macro news. The methodology is structural vector autoregression. Theoretical ‘restrictions’ on unexpected changes to this multivariate linear model allow identifying economically

In financial markets, risk refers to the probability distribution of future returns. Uncertainty is a broader concept that encompasses ambiguity about the parameters of this probability distribution. There are various types of measures seeking to estimate risk and uncertainty: [1] realized and

Nowcasting is a modern approach to monitoring economic conditions in real-time. It makes financial market trading more efficient because economic dynamics drive corporate profits, financial flows and policy decisions, and account for a large part of asset price fluctuations. The main technology

When macroeconomic conditions change rational inattention and cognitive frictions plausibly prevent markets from adjusting expectations for futures interest rates immediately and fully. This is an instance of information inefficiency. The resulting forecast errors give rise to joint predictability

An equilibrium model for U.S. Treasury yields explains how macroeconomic trends and related expectations for future short-term interest rates shape the yield curve. Long-term yield trends arise from learning about stable components in GDP growth and inflation. They explain the steady rise of