The most basic tenet of financial theory is that risk and expected return are related. One widely used measure of risk is volatility. As far back as 1976, with the publication of Fischer Black’s “Studies of Stock Price Volatility Changes,” financial economists have known that volatility and

Do common equity factors suffer during bear markets? Undoubtedly, the market factor is a rather unpleasant investment during bear markets, but what about the long-short factors? Are they able to deliver performance? The research paper by Geertsema and Lu (2021) provides several answers and

Inflation — what’s that? … It has been quite a while since inflation has been considered a problem. Today, however, the angst surrounding the possibility of a resurgence in inflation is real and “top of mind” for investors. If the current fear becomes a reality, how should investors react?

One of the primary benefits of Tactical Asset Allocation (TAA) is the ability to manage losses during major market declines. TAA does that by reducing allocation to risk asset classes like stocks and real estate, and increasing allocation to defensive assets like bonds and gold. In this post, we

Building on our last article regarding best practices for quantitative finance research groups, this article asks the question: What is the best setup and culture for a quant team? This question may have different answers depending on who you ask. Fortunately, there are some glimpses and statements

ETFs are a negligible owner of US stocks Primary and secondary ETF trading has not grown quicker than total stock trading The impact of ETFs on stocks is less strong than frequently suggested INTRODUCTION “Software is eating the world.” The venture capitalist Marc Andreessen wrote these words

Stock and options markets can disagree about a stock’s value because of informed trading in options and/or price pressure in the stock. This difference between the options implied stock price and the actual traded stock price (DOTS) can give insight into the markets view on the expected future

Equities provide significant long-term returns, but the growth certainly is not constant or even stable. Anyway, this holds for almost every financial asset. Bear markets alternate bull markets, and expansion periods rotate with recession periods. Since recessions and bear markets come hand in hand

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

It’s early in the morning and the markets are about to open. As an individual trader/investor, or perhaps the manager of a group of traders/investors, you are intensely studying the latest news feed that you think may have an impact on your portfolio. Amongst the other plethora of tools at your

Happy new year! A very quick post from me this month - I'm trying to get ready for teaching next week and also cracking on with my latest book. On the Systematic Trader podcast I recently discussed using a clustering algorithim to group instruments. Using my software, pysystemtrade, I can get a

This is an independent test of Optimum3, a tactical asset allocation strategy from Todd Tresidder of FinancialMentor.com. Optimum3 starts as a momentum strategy similar to many of the TAA strategies we track. It combines that with a unique approach to portfolio optimization to enforce a degree of

Stock returns can be heavily impacted by certain events. Sometimes these events are unexpected or a surprise (natural disasters, global pandemics, terrorism) and other times they are scheduled (presidential elections, earnings announcements, financial data releases). We can use pandas to obtain

Indisputably, we are witnesses of an ETF mega boom. From passive to active ETFs, their numbers seem to be ever-increasing. Since these exchange-traded funds can be excellent (accessible, transparent, liquid) instruments, it is a great necessity to examine their possible usage in active and

Floating rate ETFs pursue differentiated strategies Some of them are highly correlated to equities, limiting any diversification benefits The correlation with interest rates and inflation has been low INTRODUCTION Despite the consensus on high inflation being transitory in 2021, the five-year,

In general, a factor is described as a characteristic that can be associated with a group of assets, and it helps to explain their returns and risks. As noted in the literature focusing on CAPM, the market itself can be viewed as the primer and most significant equity factor. Besides the market

I’ve been seeing lots of seasonality type charts on the S&P500 where they take the average return for each day of the year and then create a return curve for the year. The chart often ‘shows’ the sell in May and buy in November flatness of the returns. And then the holiday end of the year

The Time-Varying Relation between Stock Returns and Monetary Variables David G. McMillan (University of Stirling) November 2, 2021 The nature of the relation between stock returns and the three monetary variables of interest rates (bond yields), inflation and money supply growth, while oft studied,

In our 2016 book “Your Complete Guide to Factor-Based Investor” Andrew Berkin and I recommended that due to the risks of data mining (or p-hacking)—researchers torture the data until it confesses—for you to consider investing in a factor it should have demonstrated a premium that was:

In Australia, if you’re serious about getting the job done effectively and efficiently, you might say: “I’m not here to f*** spiders.” Many traders act like they are, indeed, here to f*** spiders. If you’re making soup, you first need a good stock. Stock isn’t exciting. Everyone has

I was continuing from the last post. I will explain why I picked the paper I did, answer the questions from the previous post, and show my note-taking and thought process. After reading hundreds if not thousands of whitepapers, blogs, or articles, this is my distilled version of how I approach it. I

Previous articles in this series examine, from a digital signal processing (DSP) frequency domain perspective, various types of digital filters used by quantitative analysts and market technicians to analyze and transform financial time series for trend-following purposes. An Introduction to Digital

In a previous post we analyzed the performance of US Sectors using SPDR Sector ETFs. Now, let’s dive into the analysis of sectors using S&P 500 components and some measures of its performance. Before going any further, it is important to note that there are some differences between the Sector

The present author, together with Marcos López de Prado, has just published the article How backtest overfitting in finance leads to false discoveries in Significance, a journal of the British Statistical Society. The published article is now available at the Significance (Wiley) website. This

Allocations to illiquid assets(1) have become increasingly popular, thus requiring asset managers to consider portfolio-wide liquidity characteristics. Although determining the price of illiquidity is a challenge for investors, the construction of a portfolio that includes liquidity constraints can

Learning or experimenting with Tidytext has been on my radar for at least a few years. Only recently did i have a need to pick it up. As with most learnings, they lead you down a path of more knowledge (read: rabbit holes) than you foresaw. This post is a hat-tip to the resources i used, knitting

“There is nothing new in the world except the history you do not know” – Harry S. Truman January 2022. Reading Time: Several hours. Author: FactorResearch. RESEARCH COMPENDIUM 2021 In 2021 we published more than 50 research notes on mostly quantitative strategies, but also on topics like

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

The NDX was hit especially hard last week. It fell 4.5% on the week and Friday was the lowest close since October. Many times we will see multi-day pullbacks and/or intermediate-term lows during a long-term uptrend suggest the market is primed for a bounce. But in running some studies on NDX this

Quantifying how diversified is a universe of assets is an open problem in quantitative finance, partly because there is no definite formula for diversification1. Let’s make the (reasonable) assumption that the way assets are moving together within a universe is important for its diversification.

Itzhak Ben-David, Jiacui Li, Andrea Rossi, and Yang Song contribute to the literature on the behavior of individual investors with their July 2021 study “What Do Mutual Fund Investors Really Care About?”, published in the July 2021 issue of The Review of Financial Studies. They began by noting

The internet is teeming with resources for potential alpha. How do you separate the wheat from the chaff? In this series of blog posts, I will explain my process for identifying sources worth diving deeper into and extracting some kind of benefit to a portfolio or strategy. This will be a

Equity investors are drawn to the asset class with the expectation of an attractive and consistent risk premium. But with this risk premium comes the real risk of downside volatility. Traditionally, investors have paired stocks with defensive assets like bonds to provide anti-correlative benefits,

Kind of sad, but the same intro which served last year, befits this year also. Littered with Corona, this year was not easy. But looking around me, I feel grateful. The following quote by Socrates comes to mind: “If all our misfortunes were laid in one common heap whence everyone must take an

2021 was a year of moderate factor performance Value, Quality, and Low Volatility factors generated positive returns Momentum and Size were negative INTRODUCTION We present the performance of five well-known factors on an annual basis for the last 10 years. Specifically, we only present factors

In a previous post, we discussed how the dynamics of assets are priced in the options prices. We recently came across a newly published article [1] that explored the same topic but from a different perspective that does not involve options. The conclusion of the new article [1] is consistent with

As usual, at this time of the year, let us do a short recapitulation of posts on our blog in the previous 12 months. We have published nearly 70 short analyses of academic papers and our own research articles on this blog in 2021. We want to use this opportunity to summarize 10 of them, which were

This is a test of the “Global Growth Cycle” strategy from Grzegorz Link that uses OECD Composite Leading Indicator (CLI) data to time the market. We’re going to present these results in an odd way. First, we’re going to replicate Grzegorz’s test, which (as he discusses) includes a degree

Momentum, the tendency of past winner stocks to outperform past loser stocks over the next several months, is one of the most well-documented and well-researched asset pricing anomalies. In our book, “Your Complete Guide to Factor-Based Investing,” Andrew Berkin and I present the evidence of a

In the past year, that is by far the most common question I get. Now that Quantopian went the way of the Dodo, is Zipline dead? Should we switch to a different backtesting engine? The short answer is that the rumors of Zipline’s demise are exaggerated, but let’s take it from the start. My 2019

Grid trading is an automated currency trading strategy where an investor creates a so-called “price grid”. The basic idea of the strategy is to repeatedly buy at the pre-specified price and then wait for the price to rise above that level and then sell the position (and vice versa with shorting

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

A member of The Crew recently asked me about the January Effect and if had I done any research on it. I had not. I have tested the December effect, which is buying the worst stocks of the year on December 1st, Should You Buy the Best or Worst YTD Stocks. From Investopedia, ‘The January Effect is a

We are calling it quits for the holidays. Most of us have kids and Santa is coming to town! We’ll talk about research and educate investors next week. Here are the Top 5 content pieces this year (Based on traffic): Even God would get fired as an Active Investor Does Gamma Hedging Actually Affect

Trading Down: The Effects of Active Trading on One-Month ETF Returns Ian Gray (Loyola Marymount University) December 15, 2021 Ark Investment Management (ARK), led by CIO Cathie Wood, has risen to prominence over the past few years because of its remarkable performance. Because of requirements for

No matter how you slice it, Value stocks are historically cheap compared to the past. There have been numerous articles on this topic, such as Ryan’s post here, Larry Swedroe’s post here, and more recently, Cliff Asness’ post here. Cliff’s post is one picture, shown below. 1 Source:

I’ve posted and updated the “Twas 3 Nights Before Christmas” study on the blog here several times since 2008. The study will kick in at the close today (12/21). This year I will again show the Nasdaq version of the study. While all the major indices have performed well during this period, the

This post covers an issue rarely discussed in backtesting: the day’s last real-time price shown at 4pm ET often differs slightly from the day’s official closing price determined shortly after 4pm. This is not an Allocate Smartly issue; it’s an oddity of the exchanges. Every so often this

Value stocks sharply underperformed growth stocks from 2017 to 2020, exacerbating a longer period of lackluster performance dating back to the Global Financial Crisis. The Death of Systemic Value Investing is not new news for frequent readers of the blog nor are the possible pathways to Resurrecting

Imagine you’re an asset-pricing researcher. You’ve just thought up a new variable, X, that might predict the cross-section of returns. And you’ve regressed returns on X in a market environment e of your choosing (i.e., using data on some specific time period, country, asset class, set of test