Statistical Arbitrage inside the U. S i9000. Equities Industry
Marco Avellanedaв€—вЂ and Jeong-Hyun Leeв€— Initial draft: September 11, 2008 This type: June 12-15, 2009
Abstract We study model-driven record arbitrage in U. S i9000. equities. The trading signs are produced in 2 different ways: using Primary Component Examination and employing sector ETFs. In both cases, we consider the residuals, or idiosyncratic aspects of stock results, and style them since mean-reverting procedures. This potential clients naturally to " contrarianвЂќ trading signs. The main contribution of the paper is the construction, back-testing and comparison of market-neutral PCA- and ETF- centered strategies placed on the wide-ranging universe of U. S. stocks. Back-testing shows that, following accounting for transaction costs, PCA-based tactics have an average annual Sharpe ratio of 1. 44 over the period 97 to 2007, with much stronger performances prior to 2003. During 2003-2007, the regular Sharpe percentage of PCA-based strategies was only 0. 9. Strategies based on ETFs achieved a Sharpe proportion of 1. one particular from 97 to 3 years ago, experiencing an identical degradation after 2002. All of us also bring in a method to be the cause of daily trading volume data in the indicators (which is definitely akin to applying " trading timeвЂќ in contrast to calendar time), and watch signiп¬Ѓcant improvement in functionality in the case of ETF-based signals. ETF strategies designed to use volume information achieve a Sharpe ratio of just one. 51 from 2003 to 2007. The paper also relates the performance of mean-reversion statistical arbitrage approaches with the currency markets cycle. Particularly, we analyze in detail the performance of the strategies during the liquidity problems of the summer season of 2007. We obtain results which are according to Khandani and Lo (2007) and validate their " unwindingвЂќ theory for the quant account drawdown of August 2007. в€— Courant Institute of Mathematical Savoir, 251 Mercer Street, New york city, N. Sumado a. 10012 UNITED STATES вЂ Fund Concepts, 49-51 Avenue Victor-Hugo, 75116 Rome, France.
The term record arbitrage has a variety of tactics and purchase programs. Their common features are: (i) trading indicators are methodical, or rules-based, as opposed to driven by basics, (ii) the trading book is market-neutral, in the sense that it has absolutely no beta while using market, and (iii) the mechanism to get generating extra returns is usually statistical. The concept is to make many wagers with great expected comes back, taking advantage of diversiп¬Ѓcation across stocks, to produce a low-volatility investment strategy which is uncorrelated with the marketplace. Holding times range from a couple of seconds to days and nights, weeks or maybe longer. Pairs-trading is widely assumed as the " ancestorвЂќ of record arbitrage. In the event stocks G and Q are inside the same sector or have comparable characteristics (e. g. Exxon Mobile and Conoco Phillips), one expects the results of the two stocks in order to each other after controlling to get beta. Consequently, if Pt and Qt denote the corresponding price time series, after that we can model the system because ln(Pt /Pt0 ) = О±(t в€’ t0 ) + ОІln(Qt /Qt0 ) + Xt or, in its diп¬Ђerential version, dQt dPt = О±dt + ОІ + dXt, Pt Qt (2) (1)
where Xt is a fixed, or mean-reverting, process. This procedure will be called the cointegration residual, or residual, for short, in the rest of the daily news. In many cases of interest, the go О± is usually small compared to the п¬‚uctuations of Xt and may therefore become neglected. Which means that, after controlling for beta, the long-short portfolio oscillates near some statistical balance. The style suggests a contrarian purchase strategy through which we go long 1 dollar of stock L and brief ОІ dollars of share Q in the event that Xt is usually small and, more over, go brief P and long Q if Xt is large. The stock portfolio is expected to produce a great return while valuations are coming (see Post (2007) for any comprehensive assessment on record arbitrage and co-integration). The mean-reversion paradigm is typically linked to market...
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