New strategies:
#367 – Timing S&P500 Using Full vs. Partial Employment
Period of rebalancing: Monthly
Markets traded: equities, bonds
Instruments used for trading: ETFs, futures, CFDs, funds
Complexity: Simple strategy
Bactest period: 1993 – 2017
Indicative performance: 12.01%
Estimated volatility: 11.05%
Source paper:
Rafter: Easy and Successful Macroeconomic Timing
https://ssrn.com/abstract=3050254
Abstract:
When the economy takes a turn for the worse, employment declines, right? Well, not all employment. Certainly, full-time employment declines during recessions, but concurrently part time employment rises strongly during economic downturns. An adept fiduciary can contrast the two types of employment, as well as a variety of other data, and get good broad brush investment timing decisions before an official determinationof a Recession. Using the described method enables an investor to seriously reduce drawdowns and greatly improve the reward-to-risk ratio. This works well as a stand-alone improvement to Buy & Hold or as an initial screen prior to other fundamental or technical analysis. Decisions can be made monthly, weekly or even daily for those willing to do a bit more work.
#368 – Betting Against Alpha
Period of rebalancing: Yearly
Markets traded: equities
Instruments used for trading: stocks
Complexity: Complex strategy
Bactest period: 1973-2017
Indicative performance: 10.30%
Estimated volatility: 20.29%
Source paper:
Horenstein: Betting Against Alpha
https://ssrn.com/abstract=3054718
Abstract:
I sort stocks based on realized alphas estimated from the CAPM, Carhart (1997), and Fama-French Five Factor (FF5, 2015) models and find that realized alphas are negatively related with future stock returns, future alpha, and Sharpe Ratios. Thus, I construct a Betting Against Alpha (BAA) factor that buys a portfolio of low-alpha stocks and sells a portfolio of high-alpha stocks. Using rank estimation methods, I show that the BAA factor spans a dimension of stock returns different than Frazzini and Pedersen's (2014) Betting Against Beta (BAB) factor. Additionally, the BAA factor captures information about the cross-section of stock returns missed by the CAPM, Carhart, and FF5 models. The performance of the BAA factor further improves if the low alpha portfolio is calculated from low beta stocks and the high alpha portfolio from high beta stocks. I call this factor Betting Against Alpha and Beta (BAAB). I discuss several reasons that support the existence of this counter-intuitive low-alpha anomaly.
New research papers related to existing strategies:
#212 – Scheduled Economic Announcements Effect in Stocks
Zhang, Zhao: The Macroeconomic Announcement Premium Over Business Cycles
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3053636
Abstract:
It is well documented that the average U.S. stock market excess return on days when important macroeconomic news is pre-scheduled for announcement is significantly higher than those on other trading days. Our evidence shows that this difference disappears during recessions. We further show that excess return on the announcement day increases as the expected market volatility increases one day before the announcement, but decreases as some information related uncertainties increase. The first relation is consistent with the classical risk-return trade-off theory.
The second relation, however, suggests that investors' perception of learning accuracy from the announcements weakens the risk-return relation during recessions. Our empirical findings highlight the importance of disentangling the force forming the risk-return trade-off relation and the force cyclically weakening the relation for the theory of explaining equity premium around macroeconomic announcements.
#268 – Expected Skewness and Momentum in Stocks
Cheema, Nartea: Investor Sentiment Dynamics, the Cross-Section of Stock Returns and the MAX Effect
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3036761
Abstract:
Recent evidence shows that investor sentiment is a contrarian predictor of stock returns with speculative stocks earning lower (higher) future returns than safe stocks following high (low) sentiment states. We extend this argument by conditioning expected stock returns on sentiment dynamics and show that the mispricing of speculative and safe stocks worsens with sentiment continuations but is corrected with sentiment transitions, consistent with the view that the mispricing of these stocks is sentiment-driven. We show that the unconditional contrarian return predictability of sentiment, at least in the short-run, is due to the returns of stocks in sentiment transitions. Results show that ex post, sentiment is a momentum predictor if subsequent sentiment continues; and a contrarian predictor if subsequent sentiment transitions. We show that the MAX effect can either be positive or negative contingent on sentiment dynamics. The absence of a negative MAX effect following Low sentiment states suggested by prior studies is due to the completely offsetting negative MAX effect when sentiment continues in a Low state and the positive MAX effect when sentiment transitions from a High to a Low state.
Three additional related research papers have been included into existing free strategy reviews during last 2 weeks:
A new financial research paper related to:
#25 – Small Capitalization Stocks Premium
Stefano, Serie, Simon, Lemperiere, Bouchaud: The 'Size Premium' in Equity Markets: Where Is the Risk?
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3018454
Abstract:
We find that when measured in terms of dollar-turnover, and once beta-neutralised and Low-Vol neutralised, the Size Effect is alive and well. With a long term t-stat of 5.1, the “Cold-Minus-Hot” (CMH) anomaly is certainly not less significant than other well-known factors such as Value or Quality. As compared to market-cap based SMB, CMH portfolios are much less anti-correlated to the Low-Vol anomaly. In contrast with standard risk premia, size-based portfolios are found to be virtually unskewed. In fact, the extreme risk of these portfolios is dominated by the large cap leg; small caps actually have a positive (rather than negative) skewness. The only argument that favours a risk premium interpretation at the individual stock level is that the extreme drawdowns are more frequent for small cap/turnover stocks, even after accounting for volatility. This idiosyncratic risk is however clearly diversifiable.
A new financial research paper related to volatility selling strategies:
Sepp: Gaining the Alpha Advantage in Volatility Trading
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3032098
Abstract:
We present some empirical evidence for short volatility strategies and for the cyclical pattern of their P&L. The cyclical pattern of the short volatility strategies produces an alpha in good times but collapses to the beta in bad times. We introduce a factor model with risk-aversion to explain the risk-premium of short volatility strategies as a compensation to bear losses in bad market regimes. We then consider an econometric model for statistical inference of market regimes and for optimal position sizing. Finally, we illustrate model applications for generating alpha from volatility strategies.
A new financial research paper related to all long-short equity factor strategies:
Bekjarovski: How Do Short Selling Costs and Restrictions Affect the Profitability of Stock Anomalies?
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3066750
Abstract:
Short selling frictions cannot explain the persistence of seven prominent stock anomalies. Long-only investing is robust and profitable and can be further enhanced by using a synthetic short. Moreover, portfolios restricted to stocks that are easy to short sell continue to have large and significant short anomaly alphas. I derive cost bounds for switching between implementation methods and show that the cost associated with short anomaly positions is small relative to their profitability contribution using a proprietary database of borrowing fees. Overall, the empirical evidence does not support the implications of arbitrage asymmetry that mispricing is concentrated in short positions where it is too costly to exploit.
