Quant Mashup - SR SV
Nowcasting with MIDAS regressions [SR SV]
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
- 1 week ago, 6 Sep 2020, 11:38am -
Market-implied macro shocks [SR SV]
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
- 3 weeks ago, 24 Aug 2020, 10:23am -
Measures of market risk and uncertainty [SR SV]
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
- 1 month ago, 8 Aug 2020, 09:51am -
Nowcasting for financial markets [SR SV]
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
- 1 month ago, 27 Jul 2020, 12:40pm -
Joint predictability of FX and bond returns [SR SV]
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
- 3 months ago, 25 May 2020, 10:00am -
Equilibrium theory of Treasury yields [SR SV]
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
- 4 months ago, 4 May 2020, 09:26am -
Macro trading and macroeconomic trend indicators [SR SV]
Macroeconomic trends are powerful asset return factors because they affect risk aversion and risk-neutral valuations of securities at the same time. The influence of macroeconomics appears to be strongest over longer horizons. A macro trend indicator can be defined as an updatable time series that
- 5 months ago, 13 Apr 2020, 11:29am -
A statistical learning workflow for macro trading strategies [SR SV]
Statistical learning for macro trading involves model training, model validation and learning method testing. A simple workflow [1] determines form and parameters of trading models, [2] chooses the best of these models based on past out-of-sample performance, and [3] assesses the value of the
- 5 months ago, 4 Apr 2020, 01:10pm -
The basics of low-risk strategies [SR SV]
Low-risk investment strategies prefer leveraged low-risk assets over high-risk assets. The measure of risk can be based on price statistics, such as volatility and market correlation, or fundamental features. The rationale for low-risk strategies is that leverage is not available for all investors
- 5 months ago, 29 Mar 2020, 12:26pm -
How loss aversion increases market volatility and predicts returns [SR SV]
Loss aversion means that people are more sensitive to losses than to gains. This asymmetry is backed by ample experimental evidence. Loss aversion is not the same as risk aversion, because the aversion is disproportionate towards drawdowns below a threshold. Importantly, loss aversion implies that
- 5 months ago, 21 Mar 2020, 09:16pm -
Lagged correlation between asset prices [SR SV]
Efficient market theory assumes that all market prices incorporate all information at the same time. Realistically, different market segments focus on different news flows, depending on the nature of the traded security and their research capacity. Such specialization makes it plausible that lagged
- 6 months ago, 7 Mar 2020, 10:48am -
Detecting market price distortions with neural networks [SR SV]
Detecting price deviations from fundamental value is challenging because the fundamental value itself is uncertain. A shortcut for doing so is to look at return time series alone and to detect “strict local martingales”, i.e. episodes when the risk-neutral return temporarily follows a random
- 6 months ago, 23 Feb 2020, 10:04am -
Tracking investor expectations with ETF data [SR SV]
Retail investors’ return expectations affect market momentum and risk premia. The rise of ETFs with varying and inverse leverage offers an opportunity to estimate the distribution of such expectations based on actual transactions. A new paper shows how to do this through ETFs that track the
- 7 months ago, 8 Feb 2020, 08:54pm -
Machine learning and macro trading strategies [SR SV]
Machine learning can improve macro trading strategies, mainly because it makes them more flexible and adaptable, and generalizes knowledge better than fixed rules or trial-and-error approaches. Within the constraints of pre-set hyperparameters machine learning is continuously and autonomously
- 7 months ago, 3 Feb 2020, 10:09am -
The q-factor model for equity returns [SR SV]
Investment-based capital asset pricing looks at equity returns from the angle of issuers, rather than investors. It is based on the cost of capital and the net present value rule of corporate finance. The q-factor model is an implementation of investment capital asset pricing that explains many
- 7 months ago, 26 Jan 2020, 11:16am -
The predictive superiority of ensemble methods for CDS spreads [SR SV]
Through R or Python we can nowadays apply a wide range of methods for predicting financial market variables. Key concepts include penalized regression, such as Ridge and LASSO, support vector regression, neural networks, standard regression trees, bagging, random forest, and gradient boosting. The
- 8 months ago, 12 Jan 2020, 09:19pm -
How market liquidity causes prices distortions [SR SV]
Liquidity is a critical force behind market price distortions (and related trading opportunities). First, the cost of trading in and out of a contract gives rise to a liquidity premium. Second, the risk that transaction costs will rise when market conditions necessitate trading commands a separate
- 8 months ago, 28 Dec 2019, 06:54pm -
Rebalancing and market price distortions [SR SV]
Price distortions are an important source of short-term trading profits, particularly in turbulent markets. Here price distortions mean apparent price-value gaps that arise from large inefficient flows. An inefficient flow is a transaction that is not motivated by rational risk-return optimization.
- 9 months ago, 15 Dec 2019, 07:57pm -
Equity return anomalies and their causes [SR SV]
The vast range of academically researched equity return anomalies can be condensed into five categories: [1] return momentum, [2] outperformance of high valuation, [3] underperformance of high investment growth, [4] outperformance of high profitability, and [5] outperformance of stocks subject to
- 9 months ago, 8 Dec 2019, 08:04pm -
Basic factor investment for bonds [SR SV]
Popular factors for government bond investment are “carry”, “momentum”, “value” and “defensive”. “Carry” depends on the steepness of the yield curve, which to some extent reflects aversion to risk and volatility. “Momentum” relates to medium-term directional trends, which in
- 9 months ago, 23 Nov 2019, 01:34am -
Endogenous market risk: updated primer [SR SV]
Endogenous risk arises from the interaction of financial market participants, as opposed to traded assets’ fundamental value. It often manifests as feedback loops after some exogenous shock. An important type of endogenous market risk is setback risk, which refers to the asymmetry of the upside
- 10 months ago, 16 Nov 2019, 10:11am -
A method for de-trending asset prices [SR SV]
Financial market prices and return indices are non-stationary time series, even in logarithmic form. This means not only that they are drifting, but also that their distribution changes overtime. The main purpose of de-trending is to mitigate the effects of non-stationarity on estimated price or
- 10 months ago, 4 Nov 2019, 09:06am -
Tradable economics [SR SV]
Tradable economics is a technology for building systematic trading strategies based on economic data. Economic data are statistics that – unlike market prices – directly inform on economic activity. Tradable economics is not a zero-sum game. Trading profits are ultimately paid out of the
- 10 months ago, 28 Oct 2019, 09:12am -
Crowded trades: measure and effect [SR SV]
One measure of the crowdedness of trades in a portfolio is centrality. Centrality is a concept of network analysis that measures how similar one institution’s portfolio is to its peers by assessing its importance as a network node. Empirical analysis suggests that [1] the centrality of individual
- 11 months ago, 13 Oct 2019, 07:15pm -
The quantitative path to macro information efficiency [SR SV]
Financial markets are not information efficient with respect to macroeconomic information because data are notoriously ‘dirty’, relevant economic research is expensive, and establishing stable relations between macro data and market performance is challenging. However, statistical programming
- 11 months ago, 21 Sep 2019, 02:55am -
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
- 1 year 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 year 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
- 1 year 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 year 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 year 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 year 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
- 1 year 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,
- 1 year 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
- 1 year 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
- 1 year 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
- 1 year 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
- 1 year 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
- 1 year 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
- 1 year 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
- 1 year 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
- 1 year 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
- 1 year 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
- 1 year 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
- 1 year 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
- 1 year 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
- 1 year 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
- 1 year 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
- 1 year 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
- 1 year 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
- 1 year ago, 7 Jan 2019, 09:51am -