New strategies:
#181 – Catching "Falling Knife" Stocks
Period of rebalancing: Monthly
Markets traded: equities
Instruments used for trading: stocks
Complexity: Complex strategy
Bactest period: 2001 – 2011
Indicative performance: 23.09%
Estimated volatility: not stated
Source paper:
Arendarski: Tactical allocation in falling stocks: Combining momentum and solvency ratio signals
http://www.wne.uw.edu.pl/inf/wyd/WP/WNE_WP67.pdf
Abstract:
We identified 4500 US stocks with year ending losses of 50 percent or more during the 2001-2011 period. We screened our "falling knives" for financial strength to promote a greater likelihood of recovery and minimize any survivorship bias. We added the constraints of Altman Z-Scores, debt/equity ratio, and current ratio to our data set. We use GARCH-in-mean model to control the risk of the strategies. The results show consistent improvement of risk standardized return profiles of the strategies in comparison with buy and hold strategy.
#182 – Dual Listed Stock Arbitrage
Period of rebalancing: Intraday
Markets traded: equities
Instruments used for trading: stocks
Complexity: Very complex strategy
Bactest period: 1993 – 2006
Indicative performance: 10.10%
Estimated volatility: 12.76%
Source paper:
Schultz, Shive: Mispricing of Dual-Class Shares: Profit Opportunities, Arbitrage, and Trading
http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.158.6695&rep=rep1&type=pdf
Abstract:
This is the first paper to examine the microstructure of how mispricing is created and resolved. We study dual class-shares with equal cash-flow rights, and show that a simple trading strategy exploiting gaps between their prices creates abnormal profits after transactions costs and a battery of conservative robustness checks. Trade data from TAQ shows that investors shift their trading patterns to take advantage of gaps. Contrary to common perception, long-short arbitrage plays a minor part in eliminating gaps, and one-sided trades correct the bulk of them. We also show that the more liquid share class is, more often than not, responsible for the price discrepancies. Our findings have implications for the literature on risky arbitrage and asset pricing more generally.
New research paper related to existing strategy:
#90 – Pairs Trading with ADRs
Bryan: Do ADRs violate the Law of One Price? Deviations from Price Parity in the Absence of Fundamental Risk
http://www.olin.wustl.edu/Documents/CRES/Bryan.pdf
Abstract:
The Law of One Price states that identical goods should carry identical prices. Through this research, I built upon previous studies to assess the validity of the Law of One Price as applied to emerging market American Depository Receipts (ADRs). I found that price parity was enforced for most ADRs most of the time; however, there were many ADRs that deviated from parity significantly for extended periods of time. In order to further investigate these deviations from price parity, I separated my analysis into three components. I first conducted a regression analysis in order to isolate the variables driving deviations from price parity and to uncover their relationships with those price deviations. The results of this analysis reveal the importance of corrective arbitrage in enforcing price parity. In support of previous research, the results of this regression analysis indicate that both U.S. and home market sentiment have a significant impact on the relative prices of the ADRs and their underlying shares. Secondly, controlling for the variables included in my regression analysis, I investigated whether deviations from price parity arise in relation to annual corporate earnings announcements, and found that they do not create significant price divergence. Finally, I analyzed whether deviations from price parity create profitable arbitrage opportunities that investors could capture with a simple arbitrage strategy. The results of this portion of my analysis indicate that investors can profit from large price deviations, because price parity is almost always restored in the long-term. Interestingly, I found that price convergence occurs more quickly and yields larger arbitrage profits when the home market shares are overvalued relative to their ADR counterparts than when the opposite is true. As far as I am aware, this is a novel finding with significant implications.
