Quantpedia Premium Update – January 7th

New Strategies:

#1083 – Adjusted Momentum Strategies in Indian Stocks

Period of rebalancing: Monthly
Markets traded: equities
Instruments used for trading: stocks
Complexity: Complex strategy
Backtest period: 2008-2024
Indicative performance: 11.47%
Estimated volatility: 24.5%

Source paper:

Rajan Raju: Shades of Momentum: Alternative Momentum Metrics and their Dissipation in Indian Equities
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4977717
Abstract:
This study explores the performance and dissipation of momentum strategies in the Indian equity market, focusing on four different momentum metrics: academic momentum, volatility-adjusted momentum, idiosyncratic momentum, and information discreteness momentum. Using decile and long-short factor portfolios, we compare the effectiveness of each momentum metric in generating excess returns over the risk-free rate. Our analysis spans from December 2008 to September 2024 and incorporates both equal-weighted and market-weighted strategies. The results indicate that all four metrics capture momentum effects, but volatility-adjusted and information discreteness momentum deliver higher risk-adjusted returns. We further examine how the momentum effect dissipates over time by increasing the holding period from 3 to 12 months. Our findings show that while shorter holding periods generate substantial momentum returns, these effects weaken significantly as the holding period lengthens, suggesting that momentum strategies are most effective over shorter durations.

#1084 – Inflation Risk Premium in Stocks During FOMC Announcements

Period of rebalancing: Monthly
Markets traded: equities
Instruments used for trading: stocks
Complexity: Complex strategy
Backtest period: 1994-2023
Indicative performance: 9.52%
Estimated volatility: 16.88%

Source paper:

Ai, Hengjie and Hu, Xinxin and Pan, Xuhui (Nick): Nominal rigidity and the inflation risk premium: identification from the cross section of equity returns
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5032223
Abstract:
Inflation risk premium is hard to identify in the data, because inflation induced by real shocks and that by nominal shocks carry risk premiums with opposite signs. We show that in the Calvo model of price rigidity, a firm’s exposure to inflation risk –induced by monetary policy– is a monotonic function of its profit margin. Using profit margin sorted portfolios around pre-scheduled FOMC announcements, we identify an inflation risk premium from the cross-section of equity returns that supports the Calvo mechanism of price adjustment. We also develop a continuous-time Calvo model to guide our empirical analysis and provide an explanation for the inflation risk premium observed in the data.

#1085 – Micro Alphas

Period of rebalancing: Monthly
Markets traded: equities
Instruments used for trading: CFDs, ETFs, funds, futures
Complexity: Very complex strategy
Backtest period: 1990-2024
Indicative performance: 16.16%
Estimated volatility: 19.89%

Source paper:

Hull, Blair and Bakosova, Petra and Cocquemas, Francois and Sinclair, Euan and Fast, Petri: Micro Alphas
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5035294
Abstract:
We introduce the concept of micro alphas, weak signals that may not reach statistical significance individually, but when combined, generate predictability for the equity risk premium. Unlike previous predictability studies born out of the Goyal and Welch (2008) critique, predictors do not have to exhibit statistical significance consistently over the sample for them to be considered. Though the recent update from Goyal, Welch, and Zafirov (2024) is more nuanced than the original, it still evaluates candidate variables against an only partially relevant criteria. Borrowing from the machine learning literature, we further apply transformations and feature selection in a cross-validated walk-forward way, in order to capture potentially non-linear and time-dependent effects. Using an elastic net model, we present a strategy demonstrating consistent excess returns over the S&P 500, and discuss methods for continually improving the model.

#1086 – Hierarchical Futures Pair Trading Strategy

Period of rebalancing: Daily
Markets traded: commodities
Instruments used for trading: futures
Complexity: Very complex strategy
Backtest period: 2016-2023
Indicative performance: 12.22%
Estimated volatility: 2.81%

Source paper:

Yang, Shuo and Huang, Ke and Chen Yao-wen: Research on Hierarchical Futures Pair Trading Strategy Based on Machine Learning and Kalman Filter
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5017127
Abstract:
Pair trading, as a significant arbitrage strategy, profits from the residuals between asset pairs. This study aims to explore the application of machine learning and Kalman filtering techniques in pair trading to optimize traditional strategies, enhancing both the return and stability of the strategy. Specifically, we address two issues: (1) how to improve the pairing efficiency and stability of assets, and (2) how to reduce noise interference and generate dynamic trading signals that enhance returns. Empirical results demonstrate that the pair trading strategy based on machine learning and Kalman filtering holds a significant advantage in hedge trading. This strategy enhances the cointegration pairing efficiency using the DTW clustering algorithm and employs Kalman filtering to eliminate noise, successfully increasing the accuracy and stability of trading signals. Additionally, utilizing the half-life as a sliding window to calculate the z-value (trading signal) allows the strategy to more flexibly seize trading opportunities. The empirical results indicate that this strategy has achieved favorable returns in backtesting, with robustness and effectiveness that can provide investors with valuable strategic optimization insights.

#1087 – Inflation Gamble Stocks

Period of rebalancing: Monthly
Markets traded: equities
Instruments used for trading: stocks
Complexity: Complex strategy
Backtest period: 1986-2024
Indicative performance: 18.27%
Estimated volatility: 17.8%

Source paper:

Bonaparte, Yosef and Korniotis, George M. and Kumar, Alok and Vosse, Melina: The Inflation Gamble
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5039068
Abstract:
This paper identifies a new link between inflation and asset prices. Our key conjecture is that lottery-type investments will be attractive to inflation-sensitive investors when inflation rises, as they feel “poorer” and attempt to mitigate inflation-induced loss in purchasing power. Consistent with this conjecture, we find that high inflation lowers risk aversion, strengthens skewness preference, and increases demand for investments that resemble lotteries. Due to increased gambling demand, lottery-type stocks become more overpriced and earn lower returns in the future. This negative relation is stronger for lottery-type stocks that have greater sensitivity to inflation and are harder to arbitrage. Further, lottery-type stocks with high retail trading and those located in regions with stronger gambling propensity become more overpriced. Together, these findings indicate that increased gambling demand in high inflationary environments generates predictable patterns in stock returns.

#1088 – End of Day Reversal in the Cross-Section of Stocks

Period of rebalancing: Intraday
Markets traded: equities
Instruments used for trading: stocks
Complexity: Complex strategy
Backtest period: 1993-2019
Indicative performance: 8.48%
Estimated volatility: 3.9%

Source paper:

Baltussen, Guido and Da, Zhi and Soebhag; Amar: End-of-Day Reversal
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5039009
Abstract:
Individual stocks experience sharp intraday return reversals in the cross-section during the last 30 minutes of the trading day. This “end-of-day reversal” pattern is economically and statistically highly significant, is distinct from market intraday momentum, and primarily comes from positive price pressure on intraday losers. The effect cannot be explained by liquidity or gamma hedging effects. Instead, two novel channels related to the attention-induced retail purchases and risk management by short-sellers at the end of the day are driving the effect.

New research papers related to existing strategies:

#807 – Production Complementarity Peer Momentum

Jin, Zuben and Li, Frank Weikai: Scope Similarity and Cross-Firm Return Predictability
https://ssrn.com/abstract=5016418
Abstract:
Using firm-level product market scope measure developed by Hoberg and Phillips (2022), we identify a new dimension of cross-firm linkages based on scope similarity. We find strong contemporaneous comovement in fundamentals and stock returns for scope peers that transcend traditional industry boundaries. We show that investors do not promptly incorporate news about a firm’s scope peers, leading to predictable returns. A long-short value-weighted portfolio exploiting this delayed reaction generates a Fama and French (2015) five-factor alpha of 8.9% (t=4.10) annually. This effect is distinct from other cross-stock momentum effects and is more pronounced for stocks with lower visibility and higher arbitrage costs. We provide corroborating evidence for the inattention channel by showing that analysts are slow to carry information across scope peers.

#167 – Idiosyncratic Momentum in Stocks

Graef, Frank and Hoechle, Daniel, and Schmid, Markus: Firm-specific versus systematic momentum
https://ssrn.com/abstract=5053270
Abstract:
We decompose stock returns into a systematic and a firm-specific component and show that the dynamics of the firm-specific return component drives the wellknown stock momentum anomaly. Our results are robust to the use of a variety of prominent factor models for return decomposition. Furthermore, we find that momentum profits are largely unaffected when the investment universe is restricted to stocks with inconspicuous factor loadings. Our empirical findings call into question the transmission mechanism from factor momentum to stock momentum proposed in recent research.

#38 – Accrual Anomaly

Kapons, Martin M. and Veenman, David: Seasonal Variation in Cash Flows and the Timing Role of Accruals
https://ssrn.com/abstract=5042551
Abstract:
We study how seasonal variation affects quarterly accruals and cash flows. We first extend the framework of Dechow, Kothari, and Watts (1998) and analytically show how seasonal variation in operating cash flows and accruals is determined by the seasonality in sales and firms’ working capital policies. Next, we empirically find that quarterly working capital accruals play a pronounced role in offsetting cash flows noise and document that this timing role varies predictably with seasonal cash flow variation. The timing role of quarterly accruals becomes somewhat less pronounced over time, which relates to a systematic decline in seasonal cash flow variation and changes in the determinants of seasonal variation-primarily reductions in firms’ inventory holdings and lengthier payment delays to suppliers. Our results add to the recent debate on the significance of the noise-reducing role of accruals, the literature on the economic determinants of accruals, and the literature on the time-series properties of earnings, cash flows, and accruals.

#183 – Optimized Currency Portfolios
#436 – A Multi Strategy Approach to Trading Foreign Exchange Futures

Castro, Pedro and Hamill, Carl and Harber, John and Harvey, Campbell R. and van Hemert, Otto: The Best Strategies for FX Hedging
https://ssrn.com/abstract=5047797
Abstract:
The question of whether, when, and how to hedge foreign exchange risk has been a vexing one for investors since the end of the Bretton Woods system in 1973. Our study provides a comprehensive empirical analysis of dynamic FX hedging strategies over several decades, examining various domestic and foreign currency pairs. While traditional approaches often focus on risk mitigation, we explore the broader implications for expected returns, highlighting the interplay between hedging and strategies such as the carry trade. Our findings reveal that incorporating additional factors-such as trend (12-month FX return), value (deviation from purchasing power parity), and carry (interest rate differential) – into hedging decisions delivers significant portfolio benefits. By adopting a dynamic, active approach to FX hedging, investors can enhance returns and manage risk more effectively than with static hedged or unhedged strategies.

#12 – Pairs Trading with Stocks

Suchato, Jirat and Wiryadi, Sean and Chen, Danran and Zhao, Ava and Yue, Michael: An Application of the Ornstein-Uhlenbeck Process to Pairs Trading
https://api.semanticscholar.org/CorpusID:274788468
Abstract:
In this paper, we conduct preliminary analysis on a pairs trading strategy using the Ornstein-Uhlenbeck process to model stock price differences and compare that to a naive pairs trading strategy using a rolling window to calculate mean and standard deviation parameters. Our preliminary findings suggest that running a pairs trading strategy with the Ornstein-Uhlenbeck process outperforms the naive pairs trading strategy on a risk-return basis. Key further research can be conducted on the selection of pairs, augmenting the investment universe, finding different criteria in pairs selection, applying more rigorous machine learning techniques to assist with forecasting pricing trends, and in integrating portfolio optimization techniques.

And several interesting free blog posts that have been published during the last 2 weeks:

Top Ten Blog Posts on Quantpedia in 2024

The year 2024 is nearly behind us, so it’s an excellent time for a short recapitulation. In the previous 12 months, we have been busy again (as usual) and have published over 70 short analyses of academic papers and our own research articles. The end of the year is a good opportunity to summarize 10 of them, which were the most popular (based on the Google Analytics ranking). The top 10 is diverse, as usual; once again, we hope that you may find something you have not read yet …