Quant Mashup - SR SV
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
- 2 weeks 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
- 4 weeks 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 month 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.
- 3 months 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
- 3 months 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
- 4 months 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
- 4 months 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
- 5 months 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
- 6 months 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
- 6 months 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
- 7 months 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
- 7 months 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
- 8 months 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,
- 9 months 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
- 10 months 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
- 10 months 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
- 11 months 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,
- 11 months 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
- 1 year 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
- 1 year 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
- 1 year 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.
- 1 year 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
- 1 year 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
- 1 year 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
- 1 year 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
- 1 year 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
- 1 year ago, 10 Jan 2022, 12:03pm -
Classifying market regimes [SR SV]
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
- 1 year ago, 27 Dec 2021, 10:43pm -
The risk-reversal premium [SR SV]
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
- 1 year ago, 11 Dec 2021, 10:52am -
How to construct a bond volatility index and extract market information [SR SV]
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
- 1 year ago, 28 Nov 2021, 08:40pm -
Fundamental value strategies [SR SV]
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
- 1 year ago, 14 Nov 2021, 07:43pm -
Measuring the value-added of algorithmic trading strategies [SR SV]
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
- 1 year ago, 18 Oct 2021, 10:36am -
Ten things investors should know about nowcasting [SR SV]
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
- 1 year ago, 5 Sep 2021, 10:00pm -
Macro trends for trading models [SR SV]
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
- 1 year ago, 23 Aug 2021, 10:31pm -
Machine learning for portfolio diversification [SR SV]
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
- 1 year ago, 9 Aug 2021, 10:08am -
Accounting data as investment factors [SR SV]
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
- 1 year ago, 26 Jul 2021, 10:17am -
Diversified reward-risk parity [SR SV]
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
- 1 year ago, 12 Jul 2021, 01:00pm -
A market-to-book formula for equity strategies [SR SV]
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
- 1 year ago, 28 Jun 2021, 11:23am -
Markets’ neglect of macro news [SR SV]
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
- 1 year ago, 14 Jun 2021, 09:23am -
Factor momentum: a brief introduction [SR SV]
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
- 2 years ago, 31 May 2021, 09:49am -
The macro forces behind equity-bond price correlation [SR SV]
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,
- 2 years ago, 17 May 2021, 09:45am -
Macro information waste and the quantamental solution [SR SV]
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
- 2 years ago, 3 May 2021, 10:55am -
Statistical arbitrage risk premium [SR SV]
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
- 2 years ago, 19 Apr 2021, 11:11am -
Building a real-time market distress index [SR SV]
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
- 2 years ago, 22 Mar 2021, 09:33pm -
Understanding the disposition effect [SR SV]
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
- 2 years ago, 22 Feb 2021, 10:07am -
Contagion and self-fulfilling dynamics [SR SV]
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
- 2 years ago, 8 Feb 2021, 08:32am -
Macro uncertainty as predictor of market volatility [SR SV]
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
- 2 years ago, 25 Jan 2021, 11:11am -
Classifying market states [SR SV]
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
- 2 years ago, 10 Jan 2021, 10:36am -
What traders should know about seasonal adjustment [SR SV]
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
- 2 years ago, 26 Dec 2020, 06:39pm -
Inflation and precious metal prices [SR SV]
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
- 2 years ago, 14 Dec 2020, 10:30am -