Quantpedia Premium Update – August 8th

New strategies:

#1156 – Lottery Effect in Cryptocurrencies

Period of rebalancing: Weekly
Markets traded: cryptocurrencies
Instruments used for trading: cryptocurrencies
Complexity: Moderately complex strategy
Backtest period: 2017-2024
Indicative performance: 28.08%
Estimated volatility: 66.86%

Source paper:

Babiak, Mykola and Bianchi, Daniele: Extrapolation Bias and the Lottery Effect: Evidence from Cryptocurrency Markets
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5315949
Abstract: We document a pronounced lottery effect in cryptocurrency markets, where tokens with extreme positive returns experience significant subsequent underperformance. We provide evidence that investors overestimate performance persistence, leading to a more pronounced mispricing when lottery-like payoffs occur recently. The anomaly is amplified among costly-to-arbitrage cryptocurrencies due to trading frictions and transaction costs. Using on-chain and social media metrics, we analyze investor activity and find that extremely strong performance attracts disproportionate attention, amplifying behavioral biases. These results highlight how attention-driven demand, combined with investor extrapolation bias, generates cross-sectional predictability that remains difficult to exploit due to transaction costs and liquidity constraints.

#1157 – Return Dispersion Dynamic Momentum Strategy

Period of rebalancing: Monthly
Markets traded: equities
Instruments used for trading: stocks
Complexity: Complex strategy
Backtest period: 1927-2023
Indicative performance: 12.68%
Estimated volatility: 13.26%

Source paper:

Liu, Jiatao and Zhang, Yongjie and Zhang, Yuntian and Zhao, Shen: Dynamic Momentum Strategies: Return Dispersion and Predictability
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5287301
Abstract: This paper examines how the interquartile range (IQR) of cross-sectional stock returns predicts momentum profitability around business cycle turning points. We show that elevated IQR reliably signals critical economic transitions—particularly from recession to recovery—when investor opinions about economic conditions become dispersed, inducing significant reversals in momentum strategies. Momentum strategies exhibit substantially negative returns during high-IQR periods, primarily driven by pronounced recoveries among previously undervalued cyclical loser stocks. Out-of-sample analyses confirm that IQR robustly forecasts momentum crashes and reversals, substantially outperforming established predictors. We propose a simple dynamic factor timing strategy based on IQR, significantly enhancing momentum strategy performance in real-time. Global evidence across 52 international markets further supports the predictive power of IQR, highlighting its importance as a forward-looking indicator of momentum dynamics. Our findings provide a practical and robust framework for investors to dynamically manage momentum exposure across varying economic states.

#1158 – Fundamental Growth Index Strategy

Period of rebalancing: Yearly
Markets traded: equities
Instruments used for trading: stocks
Complexity: Complex strategy
Backtest period: 1969-2024
Indicative performance: 12.4%
Estimated volatility: 16.5%

Source paper:

Arnott, Robert D. and Brightman, Chris and Harvey, Campbell R. and Nguyen Que and Shakernia, Omid: Fundamental Growth
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5342700
Abstract: Conventional growth indices suffer from two important shortcomings. First, stocks that are anti-value (very expensive) are not necessarily growth stocks. The decision to include a stock in a growth index should be based on fundamental growth measures, such as growth in sales, profits, or R&D spending rather than price-based measures. Second, when these indices are weighted by objective measures of growth (rather than by market capitalization) performance markedly improves. Overpaying for growth is unhelpful. We also assert that some stocks with poor growth prospects and unattractive valuations may have no place in either value or growth indices.

#1159 – Momentum and Skewness in Currency Returns

Period of rebalancing: Monthly
Markets traded: currencies
Instruments used for trading: futures, forwards, CFDs
Complexity: Complex strategy
Backtest period: 2000-2024
Indicative performance: 2.28%
Estimated volatility: 3.51%

Source paper:

Liu, Yi: How to Maximize Momentum Returns in Foreign Exchange Markets?
https://ssrn.com/abstract=5321067
Abstract: This paper examines momentum and reversal patterns in currency carry trades using data from 42 countries. First, we document robust momentum effects in currency returns over six-month holding periods, consistent with prior literature, but find these are systematically followed by return reversals in subsequent months. More importantly, we demonstrate that these momentum and reversal effects originate from distinct subsets of currencies, suggesting momentum and reversal should not be viewed as sequential phases in the lifecycle of the same currency pairs. Next, we show that double-sorting currencies based on skewness and kurtosis allows investors to construct momentum portfolios that improve risk-adjusted returns compared to conventional momentum strategies while substantially reducing subsequent reversal effects. In contrast, we find that volatility-based sorting approaches fail to deliver similar performance enhancements. However, momentum strategies show inconsistent performance during recessions, with no improvement from strategy adjustments, suggesting that the breakdown of momentum patterns during crises may reflect more fundamental changes in market dynamics rather than measurement or implementation issues. These findings have important implications for both asset pricing theory and currency market practice. The results challenge simple risk-based explanations for currency momentum, while supporting the growing literature on investor behavior and limits to arbitrage in foreign exchange markets. For practitioners, our enhanced momentum strategy offers a concrete approach to improve trading performance, while our recession analysis provides important caveats about strategy limitations during market stress periods.

#1160 – Geo-Informed Equity Signals

Period of rebalancing: Weekly
Markets traded: equities
Instruments used for trading: ETFs
Complexity: Very complex strategy
Backtest period: 2021-2024
Indicative performance: 25.22%
Estimated volatility: 25.78%

Source paper:

Seruga, David Neven and Vojtko, Radovan: Cross-Country Equity Prediction Using a Geographically Informed Machine Learning Model
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5335161
Abstract: This study demonstrates that the value of a geographically informed machine learning model for global equity returns lies not in its raw predictions, but in the deviations from simple price-based benchmarks like moving averages. Large differences between the model’s forecasts and these benchmarks reveal potential mispricings, offering improved signals for tactical country allocation. This approach outperforms traditional indicators and an equally weighted benchmark portfolio, highlighting the benefit of integrating spatial relationships in equity prediction.

#1161 – The Fourth-Quarter Earnings Effect

Period of rebalancing: Monthly
Markets traded: equities
Instruments used for trading: stocks
Complexity: Very complex strategy
Backtest period: 1989-2023
Indicative performance: 16.27%
Estimated volatility: 34.68%

Source paper:

Binz, Oliver and Kapons, Martin: The Fourth-Quarter Earnings Effect
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5346432
Abstract: We document that firms report lower earnings in the fourth quarter than in interim quarters. The effect is robust to controlling for firms’ business environment and time-invariant factors, persists across time and the earnings distribution, concentrates in accrual expense estimates, and is pronounced for smaller firms. The evidence supports the hypothesis that low investment in internal information systems drives the effect. Analysts are systematically negatively surprised in the fourth quarter, and stock returns around negative earnings announcement surprises fall less and reverse more quickly in the fourth quarter than in interim quarters. Exploiting these patterns yields abnormal stock returns.

New research papers related to existing strategies:

#563 – Currency Factor Momentum

Bartel, Merlin and Hanke, Michael and Petric, Sebastian: FX Factor Momentum Pre-and Post-GFC
https://ssrn.com/abstract=5289093
Abstract: Building on the well-documented role of dollar and carry factors in global currency research, this paper investigates FX factor momentum in a systematic manner. We analyze the performance of factor momentum strategies on various sets of developed and emerging market currencies. We find that the performance of FX factor momentum strategies depends on the time period (pre- vs.\ post-GFC) and the particular set of currencies used to construct the factors. Comparing statistical factors from PCA across time reveals structural shifts in the cross-section of currencies that affect the performance of these strategies. Relating economic factors to statistical factors yields further insights into the causes for performance differences between different variants of FX factor momentum strategies.

#20 – Volatility Risk Premium Effect
#188 – Short-term Adaptive Reversal in S&P 500 Index

Kajander, Akseli and Suominen, Matti: Short-term Market Reversals and the S&P 500 Index Option Returns
https://ssrn.com/abstract=5284206
Abstract: We provide new evidence for the demand based-option pricing theory and limits of arbitrage in option pricing. We document that since the financial crisis, the S&P 500 index futures have exhibited short-term return reversal at a daily frequency and that the return reversals are larger at times of futures market illiquidity and high put-call ratio in the options’ market. These return reversals create a sizable transaction cost to those writers of S&P 500 index options, who hedge their exposures in the futures market and rebalance their hedges frequently. Due to a positive gamma in options, in case of return reversals in the underlying, the option writers who frequently rebalance their hedging portfolios end up continuously buying high and selling low, losing money in this activity. In line with the demand based-option pricing theory, and limits of arbitrage, the returns to writing unhedged straddles are more positive, and the returns to straddle replicating portfolios (hedging portfolios) are more negative, when futures markets are illiquid. We show that less than perfect hedging, or rebalancing the hedges only weekly, generate higher risk-adjusted returns for option writers, than hedging fully and rebalancing the hedges daily. Hedging strategies that make use of the futures return predictability, due to return reversals, generate even higher risk-adjusted returns. We show also that index options’ implied volatility and the put-call ratio predict positively the returns to writing unhedged straddles and the futures market illiquidity, and negatively the returns to straddle replicating portfolios.

#699 – Stock and Bond Returns Predict Currency Returns

Yamani, Ehab Abdel-Tawab: The Role of Stock and Bond Returns in the Cross-Section of Currency Returns
https://ssrn.com/abstract=5286382
Abstract: This paper offers a new risk-based explanation for the cross-section of currency excess returns using financial market drivers emanating from returns in stock and bond markets across 20 countries for the period of 1996-2019. We identify a global stock (and bond) risk factor, defined as a long-short portfolio of buying currencies with high sensitivities to stock (bond) returns and selling currencies with low sensitivities to stock (bond) returns. Results show that currencies with high exposures to stock (bond) returns have high (low) expected returns, and vice versa, even after controlling for popular determinants of currency returns.

#4 – Overnight Anomaly

Glasserman, Paul and Krstovski, Kriste and Laliberte, Paul-Robert and Mamaysky, Harry: Does Overnight News Explain Overnight Returns?
https://ssrn.com/abstract=5336382
Abstract: Over the past 30 years, nearly all the gains in the U.S. stock market have been earned overnight, while average intraday returns have been negative or flat. We find that a large part of this effect can be explained through features of intraday and overnight news. Our analysis uses a collection of 2.4 million news articles. We apply a novel technique for supervised topic analysis that selects news topics based on their ability to explain contemporaneous market returns. We find that time variation in the prevalence of news topics and differences in the responses to news topics both contribute to the difference in intraday and overnight returns. In out-of-sample tests, our approach forecasts which stocks will do particularly well overnight and particularly poorly intraday. Our approach also helps explain patterns of continuation and reversal in intraday and overnight returns. We contrast the effect of news with other mechanisms proposed in the literature to explain overnight returns.

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

Sunspots as a Natural Signal for Trading Wheat Futures?

When it comes to forecasting commodity prices, traders usually turn to weather patterns, supply-demand data, or economic indicators—but what if the sun itself could offer a clue? Our latest data analysis explores a surprising relationship: periods of high solar activity, measured by an increased number of sunspots, tend to precede lower long-term prices for agricultural staples like wheat and corn. The science behind it is simple—more sunspots often mean better growing conditions, which can boost crop yields and eventually put downward pressure on prices. It’s not a quick trade idea; the effects unfold over one to three years, as natural cycles gradually outweigh short-term noise from market speculation or temporary supply shocks. Unconventional? Yes. But in a market where every edge matters, even the sun might have something to say.

Cultural Calendars and the Gold Drift: Are Holidays Moving GLD ETF?

Financial markets exhibit persistent calendar anomalies, which often defy the efficient‐market hypothesis by generating predictable return patterns tied to institutional or cultural events. In this paper, we document a novel, globally pervasive drift in gold prices surrounding major wealth-oriented festivals across the four principal cultural and religious domains: Christianity, Islam, Hinduism, and East Asian syncretic traditions. While each community endows its principal holidays with gift‐giving rituals and conspicuous displays of wealth, the sole differentiator among regions is the precise timing of these festivities on the Gregorian calendar.

Our central thesis is that gold, owing to its dual role as a universal wealth reservoir and socio-cultural status symbol, experiences concentrated, holiday-induced buying pressure that yields persistent and economically material drift in the GLD ETF. By quantifying this effect across four distinct cultural calendars, we introduce a previously undocumented demand-side factor into commodity-pricing models.