Order Flow explains FX Carry Trade Strategies Tuesday, 15 September, 2015

#5 - FX Carry Trade

Authors: Breedon, Rime, Vitale

Title: Carry Trades, Order Flow and the Forward Bias Puzzle

Link: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2643531

Abstract:

We investigate the relation between foreign exchange (FX) order flow and the forward bias. We outline a decomposition of the forward bias according to which a negative correlation between interest rate differentials and order flow creates a time-varying risk premium consistent with that bias. Using ten years of data on FX order flow we find that more than half of the forward bias is accounted for by order flow --- with the rest being explained by expectational errors. We also find that carry trading increases currency-crash risk in that order flow generates negative skewness in FX returns.

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A way to an improved Size and Value Factors Tuesday, 8 September, 2015

#25 - Small Capitalization Stocks Premium Anomaly
#26 - Value (Book-to-Market) Anomaly

Authors: Lambert, Fays, Hubner

Title: Size and Value Matter, But Not the Way You Thought

Link: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2647298

Abstract:

Fama and French factors do not reliably estimate the size and book-to-market effects. We demonstrate inconsistent pricing of those factors in the US stock market. We replace Fama and French’s independent rankings with the conditional ones introduced by Lambert and Hübner (2013). Controlling ex-ante for noise in the estimation procedure, we have been able to highlight a much stronger book-to-market and size effects than have conventionally been documented similar to Asness et al. (2015). As a significant related outcome, the alternative risk factors have been found to deliver less specification errors when used to price investment portfolios.

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Are Size and Momentum economically significant in international stock markets Thursday, 3 September, 2015

#14 - Momentum Effect in Stocks
#25 - Small Capitalization Stocks Premium Anomaly

Authors: Schmidt, Von Arx, Schrimpf, Wagner, Ziegler

Title: Size and Momentum Profitability in International Stock Markets

Link: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2642185

Abstract:

We study the link between the profitability of momentum strategies and firm size, drawing on an extensive dataset covering 23 stock markets across the globe. We first present evidence of an “extreme” size premium in a large number of countries. These size premia, however, are most likely not realizable due to low stock market depth. We also show that international momentum profitability declines sharply with market capitalization. Momentum premiums are also considerably diminished by trading costs, when taking into account the actual portfolio turnover incurred when implementing this strategy. In contrast to strategies based on size, we find that momentum premia especially for medium-sized stocks still remain economically and statistically significant in most equity markets worldwide after adjusting for transaction costs.

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New academic paper analyses #75 - Federal Open Market Committee Meeting Effect on Stocks Thursday, 27 August, 2015

#75 - Federal Open Market Committee Meeting Effect on Stocks

Authors: Nilsson

Title: The Pre-FOMC Drift Explored

Link: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2640477

Abstract:

The pre-FOMC drift was first published in 2011 and is a strong driver of equity market performance over the last 30 years. The effect is able to explain approximately half of all the equity market returns over the measured period. We verify the results of prior studies. Furthermore, the report dives into conditional factors; equity market trend and monetary policy action to see if there is any difference in terms of macro variables. We find that FOMC is rather stable throughout time, macro conditions and has not been dependent on a particular Fed Chair.
 

It seems as if the markets are expecting that the FOCM will infuse optimism into equity markets as the majority of the gains occurs before the actual announcement. The effect can be due to behavioral issues and herding among market participants but can also be due to information leakage. The effect remains unexplained.

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New academic paper related to #12 - Pairs Trading with Stocks Wednesday, 19 August, 2015

#12 - Pairs Trading with Stocks

Authors: Cartea, Jaimungal

Title: Algorithmic Trading of Co-Integrated Assets

Link: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2637883

Abstract:

We assume that the drift in the returns of asset prices consists of an idiosyncratic component and a common component given by a co-integration factor. We analyze the optimal investment strategy for an agent who maximizes expected utility of wealth by dynamically trading in these assets. The optimal solution is constructed explicitly in closed-form and is shown to be affine in the co-integration factor. We calibrate the model to three assets traded on the Nasdaq exchange (Google, Facebook, and Amazon) and employ simulations to showcase the strategy's performance.

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