In “Your Complete Guide to Factor-Based Investing” Andrew Berkin and I provided six criteria that had to be met in order to determine which exhibits in the “factor zoo” are worthy of investment. For a factor to be considered, it must meet all of the following tests. To start, it must provide

Generating synthetic data is an extremely useful technique in quantitative finance. It provides the ability to assess behaviour on models using data with known behaviours. This has a myriad of applications, such as testing backtesting simulators for correct functional behaiour as well as allowing

Imagine you are an European insurer. One of your funds is an equity portfolio of EMU stocks. Under Solvency II framework, you might want to reduce your Solvency Capital Requirement (SCR) thanks to the use of derivatives to hedge some of your equity risk. However, due to your size, the only

Finding high-quality data with a long history can be challenging. We have already examined How To Extend Historical Daily Bond Data To 100 years, How To Extend Daily Commodities Data To 100 years, and How To Build a Multi-Asset Trend-Following Strategy With a 100-year Daily History. Following the

Outperformance and alpha are not the same One is the difference from a benchmark, the other is the unexplained return A contribution analysis helps understanding the return drivers INTRODUCTION Almost 90% of US drivers rate themselves safer and more skillful than average. Obviously, such perceptions

While linear correlation (aka Pearson correlation) is by far the most common type of dependence measure there are few arguably better ways to characterize\estimate the degree of dependence between variables. This is a fascinating topic I keep coming back to. There is so much for a typical geek to

In the 1970's, Richard Donchian began the trend following trend by introducing a simple breakout trading system that would make him millions over the following decades. This system was predicated on an indicator that came to bear his name the Donchian Channel. We're going to show you how

In this article, the authors explore an alternative measure of consumer demand from a unique dataset of individual credit and debit card daily transactions ( available one week after the transaction was made on average) from January 2013 to December 2019. They ask the following: Can more timely

I am introducing my most recent research on log-normal stochastic volatility model with applications to assets with positive implied volatility skews, such as VIX index, short index ETFs, cryptocurrencies, and some commodities. Together with Parviz Rakhmonov, we have extended my early work on the

We were recently asked what we thought about bonds as an investment. A lot of this was inspired by my comments on bonds via a discussion on how I personally invest. I’ll repost what I said on bonds below: What are your thoughts on bonds and commodities? In general, I’m not a fan of corporate

What are the research questions? Theories abound in the financial literature explaining the drivers of momentum and reversal in one way or another. Not surprisingly, most portray the role of public and private information as key to the underlying relationships and weigh the type of information

There has been a boom in launching tactical asset allocation ETFs However, the recent track record of these has been poor Declining stock and bond markets have created a challenging environment for these INTRODUCTION Most investment strategies become popular through short rather than long periods,

Combining Factors Christoph Reschenhofer (Vienna University of Economics and Business) July 2022 While the academic literature primarily investigates factor exposures based on covariances (i.e. beta exposure), most practitioners apply characteristics-based scorings to obtain factor portfolios. It

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,

In our book “Your Complete Guide to Factor-Based Investing,” Andrew Berkin and I presented the evidence demonstrating that momentum, both cross-sectional (CSMOM) and time-series (TSMOM), has provided a premium that has been found to be persistent across time and economic regimes, pervasive

In my last blog post, Using Historical Volatility for Parameter Adjustment, I tested using historical volatility to determine trade rules. While reading the July 2022 Technical Analysis of Stocks & Commodities, I came across an article, “Is It Too Volatile To Trade?” by Perry Kaufman. I

Just recently we posted the trend-following weights for our Robust Asset Allocation model. Something interesting happened — the model suggested zero exposure to every asset, except commodities(1) source: https://alphaarchitect.com/indexes/trend/#trendasset My knee-jerk reaction was, “Wow, never

This is the forth and final post of a short series of posts on extreme events in financial time series. In the first post, we have introduced power-law theory to describe and extrapolate the chance of extreme price movements of the S&P500 index. In the second post, we took a closer look at how

Many different measures of portfolio diversification have been developed in the financial literature, from asset weights-based diversification measures like the Herfindahl Index1 to risk-based diversification measures like the Diversification Ratio of Choueifaty and Coignard2 to other more complex

There is a very cool webinar coming up next week that I suggest everyone to register and attend link Daniel Bloch, also often listed as Daniel Alexandre Bloch has contributed a lot of research on using ML for options pricing. Also Mr Block published a very thorough free textbook options pricing that

This is the third post of a short series of posts on extreme events in financial time series. In the first post, we have introduced power-law theory to describe and extrapolate the chance of extreme price movements of the S&P500 index. In the second post, we took a closer look at how statistical

What are the Research Questions? There is abundant literature on the relationship between the business cycle and future stock returns. The traditional view is that stocks are rationally priced to immediately reflect investors’ expectations about future economic activity and that expected excess

As a portfolio manager or as a portfolio construction analyst, the most usual way to manage a fund is to elaborate a Strategic Asset Allocation (a.k.a. “SAA”), that is reviewed on a mid or low frequency, on which PM or researchers add their tactical views, i.e. a Tactical Asset Allocation

This article aims is to evaluate/demonstrate the effectiveness of hedging a long only portfolio of US equities with a short position in Russell 2000 (I used IWM ETF since I don’t have rolling future prices) using an extended version structural entropy indicator. I first read about structural

As Sam Adams and I explained in our new book, “Your Essential Guide to Sustainable Investing,” while sustainable investing continues to gain in popularity, economic theory suggests that if a large enough proportion of investors choose to favor companies with high sustainability ratings (green

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

In our last installment, we reviewed the performance–across four regions–of a machine-learning-based Sentix relative sentiment model for tactical asset allocation. The regions included: the USA, Europe, Japan, and Asia ex-Japan (referred to as USA, EUR, JPN, and AEJ, respectively, in the charts

Short sellers play a valuable role in keeping market prices efficient by preventing overpricing and the formation of price bubbles in financial markets. Market efficiency is important because an efficient market allocates capital efficiently. If short sellers were inhibited from expressing their

Marco Avellaneda has contributed tremendously to financial mathematics, and to volatility trading in particular, has passed away earlier this year. Here I will review one of his last papers on trading VIX futures. I think most readers of this blog have modeled VIX futures understand both the risks

I previously described on this blog an intuitive way of performing stress tests on a correlation matrix, which consists in shrinking a baseline correlation matrix toward an equicorrelation matrix12. A limitation of this method, though, is that it alters all the correlation coefficients of the

Despite being different metrics, CPI and breakeven inflation rates exhibited the same trends since 2003 The securities with high betas to inflation come from diverse sectors, not just from energy and commodities Portfolios often feature hidden inflation exposure that should be revealed via factor

Twitter is an interesting dataset for researchers interested in consumer beliefs. (200 million monthly active users worldwide (Elon Musk may disagree!) and about 10 million active users in Italy in 2019 (AGCOM 2020)). Inflation expectations are at the heart of any consumption and investment decision

Surprisingly, in the literature there are only few effective formulae for asset allocation. They are based on the asset types and, in theory, they should define investors’ risk appetite. For instance, a large exposure in stocks should define aggressive investment style in comparison to investing

Empirical research, including the 2017 paper “A Century of Evidence on Trend-Following Investing,” has found momentum to be a persistent and pervasive factor in returns of not only stocks but other asset classes as well, including bonds, commodities, and currencies. Recent empirical research on

We dedicated several articles to how we created 100-year history for bonds, stocks, and commodities. Now we analyze the 50 worst one-day shocks and the following days in each of the abovementioned asset classes. In addition to that, we also look at how the Multi-Asset Trend-Following strategy

More than 80% of cryptocurrency tokens trade below their first trading price Tokens are diverse in their functions, but all types have been losing money consistently Token financing seems to be more beneficial for the issuer than investors INTRODUCTION A falling stock market is not bad for everyone.

With a capitalization of $1.3 trillion, cryptocurrencies are now (2022) roughly 50% of the value of US dollars and coins. What was once a fad, has now become prominent and increasingly diverse from an investor’s point of view. In response, this article discusses five key features and concepts

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

Investing in Deflation, Inflation, and Stagflation Regimes Guido Baltussen (Erasmus University Rotterdam), et al. July 2022 We examine asset class and factor premiums across inflationary regimes. As periods of high inflation and deflation are relatively uncommon in recent history, we use a deep

Recent research shows that B/M is losing explanatory power (Asness et al. 2015, Fama-French 2015, Hou et al. 2015). Some have theorized that the decrease in effectiveness in B/M is due to the increasingly large value of intangible assets. Forty years ago the market was dominated by Kodak, General

We all know that the more indebted a company is, the greater the risk of bankruptcy. But what is really the best way to measure this indebtedness? In this post we will compare two of the best known leverage ratios: Debt/Equity (Debt-to-Equity) and Net Debt/EBITDA (Net Debt-to-EBITDA). Leverage

An innovative company has launched two ETFs to captures the night effect - the difference between stock market returns during the trading day, and when the market is closed. It is a well-documented effect that most of the market gains come overnight returns, and that day returns are relatively flat.

Christoph Reschenhofer contributes to the factor-based investment literature with his April 2022 paper, “Combining Factors,” in which he investigated the performance of multifactor portfolios formed via a combination of stock characteristics scores. He began by noting that while “the finance

Stochastic processes play a key role in modelling the behavior over time of many financial assets. These mathematical descriptions of reality help making investment decisions. They can be used to price stock market options, make Monte Carlo simulations or define probabilities of expected returns,

Value is the clear winner of YTD 2022 Value, Momentum, and Low Volatility factors were positively correlated, which changed to previous years The Quality factor performed worst, which can be explained by a bias towards tech stocks INTRODUCTION We present the performance of five well-known factors on

Asset managers are often fixated on predicting the best performing asset in the near future – be that a month ahead, six months, a year or two. Of course, it would be great to know what will appreciate in price the most (and subsequently – what to invest in right now), but all we can do is

Regular listeners to the podcast I ocasionally co-host will know that I enjoy some light hearted banter with some of my fellow podcasters, many of whom describe themselves as 'pure' trend followers, whilst I am an apostate who deserves to be cast into the outer darkness. My (main) sin? The

I was browsing LinkedIn the other day and saw a bar chart of annual average VIX levels, and noticed that they kind of go up and down as if it was a cycle. Intra-day effects of elevated volatility near open and close are well-known, as well as some day-of-week patterns. Seasonal effects of VIX are

If 2022 has taught us anything, it is that our understanding of the inflationary process is woefully incomplete. Increasingly, it seems that the easy money era of the 2010’s created a blind spot in the market: stable inflation and ample liquidity were taken for granted. The risk of high (indeed,

Most defensive and diversifying strategies generated negative returns in YTD 2022 The correlation of almost all of these strategies to equities was too high Only managed futures generated attractive diversification benefits INTRODUCTION Economics and investing are all about data, eg GDP has