Robert Shiller’s cyclically adjusted price earnings (CAPE) ratio takes a 10-year inflation-adjusted average of the S&P500’s earnings to arrive at a price/earnings metric smoothed for the business cycle. It’s useful because earnings tend to be volatile and mean reverting. For example, the

Contrary to popular belief, bonds and stocks are non linear derivatives, just as options are. They are just less obviously so. Stocks can be thought of call options on the value of a company with a strike of zero. Bonds can be seen as short put options on the value of the company with a strike of

Who Supplies Liquidity, How and When?

Around the Ising Model

Large U.S. companies spent nearly half a trillion dollars on net buybacks (cash spent on buybacks less cash raised through issuance) during the 12 months ending 6/30/2015. That’s almost as much as the buyback peak in 2007, which didn’t turn out too well. Scary! But hold on. Something that gets

Stock splits lower the stock price. But what does that mean? Most straightforwardly, do lower price stocks perform better than higher priced stocks? Soosung Hwang and Chensheng Lu examined this and published their results in the paper, "Is Share Price Relevant?". They used

As the proud father of 3 kids (to include 2 daughters), this set of papers, while a bit off the wall, made me smile a bit. In short, there seems to be a negative relationship between women and lawsuits–the more women surround an organization, the less legal trouble the organization faces. It would

Do active investment managers as a group successfully time the stock market? The National Association of Active Investment Managers (NAAIM) is an association of registered investment advisors. “NAAIM member firms who are active money managers are asked each week to provide a number which

A Diverse Momentum System Using Vanguard Allocation Funds generated a plethora of feedback. Can we improve or simplify the system? And does it hold up well if variables are changed? The systems tested in the original article rarely held the Moderate Growth (VSMGX), which allocate 60% stocks/40%

I wrote about mean reversion in my book The Ivy Portfolio back in 2008. Below is a chart from the book with a couple studies of what has happened after you buy assets down multiple years in a row. (You can also search the archives for words like “reversion” to find lots of old posts like this on

This post looks at selling one-lot options strangles on the S&P 500 Index (SPX), initiated at 52 days-to-expiration (DTE). The results in this post were derived from more than 2300 individual trades entered by the backtester. For background on the setup for the backtests, as well as the

In theory, small-cap and value stocks offer solid premiums over their large-cap and growth counterparts. In the short term, however, turning theory into real-world profits can get messy. As an example, let's review how the small-cap and value premia stack up at the moment via representative

#14 - Momentum Effect in Stocks #25 - Small Capitalization Stocks Premium Anomaly #26 - Value (Book-to-Market) Anomaly #38 - Accrual Anomaly #52 - Asset Growth Effect Authors: Fan, Opsal, Yu Title: Equity Anomalies and Idiosyncratic Risk Around the World Link:

Neural networks have long fascinated us from a distance, but quite frankly, we’ve always had lower hanging fruit to pick: there’s always been a simpler model that didn’t require us learning a whole new thing. Let’s face it, as traders we are always looking for the highest level of

Way back when I got interested in testing market efficiency, which led me to build the Lazy PCA site; and then I noticed that the principal components / drivers / ideas of almost every return time series are momentum and mean reversion. I never expected that returns could be sliced up so neatly.

Hawkes Processes

Harry Markowitz, father of modern portfolio theory, has a new paper out with Sander Gerber and Punit Pujara titled Enhancing multi-asset portfolio construction under Modern Portfolio Theory with a robust co-movement measure. You can download it here. The big take away is the introduction of a new

The past few weeks we’ve highlighted a set of research papers that go back and forth on the validity of the Fama and French “5-factor model.” A sampling of the research: The Fama French 5-Factor Paper The Kewei, Xue, and Zhang (KXZ) 4-Factor Paper (critically assesses the FF 5-factor model)

Value, size and low volatility "anomalies" have been studied for decades. Momentum has only been recently recognized by academics but a lot of practitioners have been firm believers in it for many years. Quality is the most recent of the well accepted factors but the components that go

One of the criticisms of momentum systems is they are prone to crashes when momentum reverts. The system highlighted in this article can be implemented using any number of “life style” or target-risk funds or ETFs. The system chooses from a small number of funds that reflect a range of asset

Rich Component Analysis

On average, High Frequency Trading is a young profession. At meetups, high frequency traders are likely to refer to the years prior to 2008 as “ancient history”. As a group, their attention spans might seem short and HFT strategies resemble their creators to a startling degree. However, in

In my last post I demonstrated how you can generate synthetic futures prices. In this post I am going to build on this and show how you can apply principal component analysis (PCA) to determine how much of the variability in returns each of the different futures are responsible for. Creating our

Through the traditional lens of the efficient market hypothesis, market prices stick close to their fundamental values because professional investors with large amounts of capital counteract mispricings created by “dumb” or “retail” investors. For example, if Dan the DayTrader enters sell

Monday’s market rally was accompanied by a big drop in some implied volatility measures. The VXO, which is the old calculation for the VIX, saw a decline of over 22% on Monday. The study below is one I have shown before. It looks at SPX performance the day following VXO declines of 20% or more.

A PDF of this commentary can be downloaded here. Summary Dalbar studies tell us that investors often sell after losses and wait for markets to reclaim high water marks before re-entering – behavior that is guaranteed to lead to underperformance Other, more dynamic, approaches may help investors

Following up on my previous post Is there a Relationship Between the Economy and Stock Market?, which outlined the relative performance of the U.S. stock market and underlying U.S. economy over time and market performance during economic expansions / contractions, the below provides further detail

It’s hard to overestimate the importance of modeling tail risk when it comes to the care and feeding of investment portfolios. But where to begin? The topic of studying, estimating and otherwise dissecting rare but extreme market events can be a black hole of analytical possibilities and

We’ve updated the technology behind our free tools for financial professionals. Unfortunately, this took a long time, but now that we’ve developed the framework, we’ll be able to launch new and better tools in the future. tools alpha The current core modules are the following: Allocation

Nassim Taleb, author of the Inconcerto series and, most famously, The Black Swan, is out with a new paper called Error, Dimensionality, and Predictability. You can get a copy here. To quote some of the scary bits ... From the abstract: We show how adding random variables from any distribution makes

To try and maximise return the correct recipe of ingredients must be brought together. Not only do we have to look at the quality of stock selection, but the weights and quantity of stocks required for maximising returns and minimising risk. Momentum investing looks to invest in top performing

There are two completely different ways to think about momentum: absolute and relative. At FactorWave we are largely concerned with relative (or cross-sectional) momentum. We know that stocks with positive momentum tend to outperform thse with negative momentum. So if we have a choice of two stocks:

Everyone has an opinion about what the state of the market will be in the short term or long term, never mind that stock prices follow a random walk or the possible clash between that comes between the invisible hand of the market and the regulatory rules made by policy makers. Returns in the market

About a month ago we posted on the robustness of the Novy-Marx profitability factor, which is embedded in the Fama-French 5-factor. We also highlighted potential weaknesses in the 5-factor model across international markets. Fama and French have responded with their own analysis on the 5-factor

This is the first article in a series where we will look at the performance of selling options strangles. For background on the setup for the backtests, as well as the nomenclature used in the charts and tables below, please see the introductory article for this series: Option Strangle Series -

If I were to say to you the following: “The only thing that matters in the stock market is whether the 40-week cycle and/or the 212-week cycle is bullish”, chances are you would say either: a) “Wow Jay, that’s very interesting analysis. Have you considered taking some time off?” OR, if you

Bifurcation Patterns of Market Regime Transition

Friday was the 2nd day in a row that SPY put in an unfilled gap up (though Thursday ended with very small gains.) And while the move up on Friday was strong, it still was not strong enough to erase all of Wednesday’s losses. Wednesday was a big down day that left SPX at an intermediate-term low.

Enhancing Multi-Asset Portfolio Construction Under Modern Portfolio Theory with Robust Co-Movement Measure

Introduction When hopping from univariate volatility forecasts to multivariate volatility forecast, we need to understand that now we have to forecast not only the univariate volatility element, which we already know how to do, but also the covariance elements, which we do not know how to do, yet.

It's my final week in Singapore. Contrary to hearsay the 'Red Dot' is not zero dimensional; it's as multi-layered as the time you take to investigate it. A bunch of 'lasts' in Singapore will soon be followed by many 'firsts-in-a-long-time' back in Germany.

The best links of the week ending Saturday, 07/11 as voted by our readers: Video: James Simons – Numberphile [YouTube] Value and Momentum are Highly Correlated [Dual Momentum] All Strategies Blow Up [GestaltU] Backtesting in Excel: Adding position sizing [Quants Portal] The Origins of Momentum

As this year flies by and this blog nears one year from conception (the concept was hatched at the end of this month, launched a bit later), we thought it would be cool to take a look at what articles you all thought were the most interesting over this blog’s short existence [as measured by total

The market briefly closed below the 200-day moving average this week so let’s look at some recent history market behavior around the 200-day moving average. If you took every trade (on the next open) after the $SPY closed below the 200-day moving average and held for a month, you would have a

Hour development for S&P500 since 2013 to 2015. Divided into years 2013, 2014, 2015 and All, also divided into weekdays. TIME CET, interval 1 hour. Top left ALL weekdays, top right Monday and down to Friday. (TIME CET)

Every year we invite some of the investment industry’s most creative thinkers to speak about their work at the Research Affiliates’ Advisory Panel conference. Along with Nobel laureates Vernon Smith and Harry Markowitz, the speakers at our 14th annual meeting included Campbell Harvey, Richard

We have been seeing signs in the past few days of elevated levels of fear on the part of traders and investors. Yesterday’s post on the 2nd 90% Down Volume Day in the past 2 weeks gave an indication of the excessive levels of selling taking place in the market. What are presumably being gobbled up

I like girls like my asset classes. Bubbly. ... What do you mean you don't know whether whether we should take the business or not? All money is green. ... I like my cocktails like my money. Green! ... ~~ That was the CEO sitting behind a younger me. He didn't have an off

So much for summer trading. Global markets are getting more interesting by the day. Last week, we wrote a post examining the phenomenon of 90% Down Days. Again, these are days in which at least 90% of volume on the NYSE occurred in declining stocks. Such days have often been signs of selling

Momentum is a market anomaly which many people have tried to explain but have not succeeded to a satisfactory extent. As to the source of momentum profits, others have tried to rationalize their origins whereas an opposing school of thought has searched for their origins in behavioural finance. In