Two new strategies have been added:
#402 – International Volatility Arbitrage
#403 – Cross-Sectional Seasonalities in International Government Bond Returns
Three new related research papers have been included into existing strategy reviews. And two additional related research papers have been included into existing free strategy reviews during last few weeks.
A new financial research paper has been published and is related to:
Author: Hwang, Rubesam, Salmon
Title: Overconfidence, Sentiment and Beta Herding: A Behavioral Explanation of the Low-Beta Anomaly
Link: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3224321
Abstract:
We investigate asset returns using the concept of beta herding, which measures cross-sectional variations in betas induced by investors whose beliefs about the market are biased due to changes in confidence or sentiment. Overconfidence or optimistic sentiment causes beta herding (compression of individual assets’ betas towards the market beta), while under-confidence or pessimistic sentiment leads to adverse beta herding (dispersion of betas away from the market beta). We find that beta herding is related to the low-beta anomaly, as high beta stocks underperform low beta stocks on a risk-adjusted basis exclusively following periods of adverse beta herding. As an explanation of the low-beta anomaly, we propose the persistence of bias in betas (i.e., a large difference in betas) that lasts for more than one year as market uncertainty continues.
Notable quotations from the academic research paper:
"In this study we fill the gap in the literature by investigating the bias in cross-sectional asset returns when individual asset prices move together regardless of their fundamentals. We propose a mechanism that explains this comovement in asset returns with respect to two well-known behavioral biases in finance: investor overconfidence and sentiment.
We demonstrate that the cross-sectional difference in the expected returns and betas of individual assets is suppressed when investors are overconfident about signals of the market outlook, and thus their posterior prediction of the market return is overly affected by these signals. A comparable compression of betas arises in the presence of investor sentiment. When optimistic views about the market outlook prevails, individual betas are biased towards the market beta. The opposite case is also possible: when investors are under-confident about the market outlook or their sentiment is pessimistic, the difference between individual betas increases.
This type of cross-sectional bias in betas is referred to as “beta herding” in this study because individual betas are biased (herd) towards the market beta regardless of their equilibrium risk-return relationship, when investors’ market outlook is excessively affected by their optimism or overconfidence about the market outlook. In practice, when beta herding arises, investors may buy assets whose returns increase less than the market because these assets would appear relatively cheap. Likewise, they may sell assets whose returns increase more than the market because these assets would seem to be relatively expensive and the opportunity for taking apparent profits might be hard to resist. In fact, the more confident or optimistic investors are about their market outlook, the more likely they are to trade at a price close to their view.
In our model, high and low beta stocks are not affected differently by beta herding, and thus beta herding can be easily measured by the cross-sectional variance of standardized-betas, which are equivalent to the t-statistics of beta estimates. The standardized-beta provides information on the precision of the beta estimate in addition to its magnitude, and more importantly, makes it possible to compare the dynamics of beta herding over different periods.
We find that the low-beta anomaly is observed only after periods of adverse beta herding, when the dispersion of standardized-betas increases: for value-weighted decile portfolios formed on standardized-betas, the risk-adjusted return of the high-minus-low portfolio over the 12 months following adverse beta herding is -11.4% per year, whereas the returns are not different from zero following periods of no beta herding or high beta herding. The effects of adverse beta herding on standardized-beta sorted portfolios are quite persistent and remain significant over two years."
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A new financial research paper has been published and is related to multiple equity factor strategies:
Author: Atilgan, Demirtas, Gunaydin
Title: The Cross-Section of Equity Returns in Emerging Markets
Link: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3225034
Abstract:
This study investigates the relation between a comprehensive set of firm-specific attributes and future equity returns for a sample of stocks from 27 emerging markets. Univariate analyses based on equal-weighted portfolio returns reveal that the low beta, firm size, book-to-market ratio, momentum and illiquidity anomalies are also observed in emerging markets whereas short-term reversal, left-tail risk and lottery demand effects manifest themselves in the opposite direction compared to U.S. studies. Value-weighted portfolio returns and bivariate analyses that control for firm size show that some of these results are driven by small stocks. After we control for all attributes simultaneously in a regression framework, we find that the most robust cross-sectional effects for emerging market equities are medium and short-term return momentum.
Notable quotations from the academic research paper:
"Although there is no shortage of research on the cross-section of equity returns in emerging markets, these studies are restricted in the sense that they only focus on a limited number of potential determinants of expected returns and/or they only conduct their analyses in a single country or a small group of countries. Our contribution is that we compile a large set of firm-specific attributes that can potentially impact equity returns and use a comprehensive sample of stocks from 27 emerging markets. Thus, we are able to investigate the independent information that a particular firm-specific attribute provides compared to other attributes and observe the generalizability of our results across all emerging markets. We should also note that we undertake a more modest task in this study by focusing on the potential return determinants that can be extracted from the empirical return distribution of individual equity returns. The U.S. literature also suggests various accounting-based variables as cross-sectional return determinants, however, accounting information is sparse for emerging markets and not easily comparable across countries in a large sample due to differences in accounting practices. The only exception we make is for book-to-market ratio of equity since this variable is included in all contemporary asset pricing models and book value of equity is relatively more available compared to other accounting variables for emerging markets.
To investigate the relation between each firm-specific attribute and expected stock returns, we conduct discrete univariate portfolio analyses by sorting stocks into deciles based on one firm-specific characteristic at a time. Next, we compare the one-month ahead returns of the portfolio that includes equities with the highest values of a firm-specific attribute and the portfolio that includes equities with the lowest values of a firm-specific attribute. For example, if the firm-specific characteristic under focus is market beta, Portfolio 10 contains the stocks with the highest sensitivity towards market movements and Portfolio 1 contains the stocks with the lowest sensitivity towards market movements. The decile portfolios are formed every month starting from January 1989 to December 2014. The main portfolio analysis used in this study combines all equities in the sample, therefore, stocks in each decile come from a multitude of countries.
Firm size is an important mediating variable in cross-sectional studies of equity returns. Many anomalies are driven by smaller stocks implying that some significant relations between firm characteristics and expected returns that manifest themselves in the full sample of equities may not be observed when one focuses solely on large stocks. We employ conditional (dependent) double sorts on firm size and various firm-specific attributes by grouping equities into deciles based on firm size and then into additional deciles based on a certain firm-specific attribute within each size decile. For each firm-specific attribute, this bivariate analysis provides 100 conditionally double-sorted portfolios. Portfolio 1 represents the combined portfolio of stocks with the lowest values of a firm-specific attribute in each size decile and Portfolio 10 represents the combined portfolio of stocks with the highest values of a firm-specific attribute in each size decile. We investigate whether the mean return or alpha differences between two extreme firm-specific attribute deciles is significantly different from zero. This type of analysis can also reveal whether the existence or non-existence of a relation between a certain attribute and expected returns is driven or masked by a significant correlation between the attribute and firm size.
We find that the return pattern across the market beta deciles is relatively flat, however, the decile returns drop from 1.00% to 0.32% between Portfolio 9 and 10. Despite this sharp drop, the return and alphas to the zero-cost portfolio constructed based on market beta are insignificant. The book-to-market and momentum anomalies survive after controlling for firm size using bivariate sorts. The return and alphas to the zero-cost strategy based on BM are between 75 and 96 basis points with t-statistics of between 2.74 and 3.62. The zero-cost strategy based on momentum reveals even higher returns and alphas with values between 1.85% and 2.41% and t-statistics between 3.53 and 4.44. The short-term reversal strategy still translates as short-term momentum to the emerging market setting. The return difference between the extreme one-month-lagged return deciles is 2.28% with a t-statistic of 5.91 and significantly positive alphas.
The conflicting evidence regarding the illiquidity premium that was uncovered in the univariate analyses is absent when firm size is kept stable across the Amihud’s illiquidity ratio and Zeros deciles. None of the return or alpha measures based on these two metrics are statistically different than zero. We also had found no robust relation between attributes such as idiosyncratic volatility, co-skewness and skewness earlier and these results translate to the bivariate setting as well.
For the three stock-specific left-tail risk measures, we find that the return and alpha metrics for the zero-cost strategy are all positive but statistically insignificant with t-statistics between 0.47 and 1.66. For hybrid tail risk, we observe a generally decreasing pattern of returns across the deciles although the return increases from 57 to 86 basis points from Portfolio 9 to 10. Despite this increase, the returns and alphas to the zero-cost strategy are all negative and statistically insignificant except for AF alpha. Again, there is no relation between downside beta and expected equity returns. Finally, we observe that lottery-like stocks continue to demand higher one-month-ahead returns after the dependent sorts. The return and alpha measures for the zero-cost strategy based on MAX1 and MAX5 vary between 0.96% and 1.91% with t-statistics between 1.77 and 2.76.
We observed that the firm size, book-to-market and momentum anomalies presented themselves significantly in the overall sample of emerging market equities. By looking at each region separately, we see that these significant relations generally do not show up uniformly in each region and the results encountered in the overall sample are driven by specific regions. For example, although the zero-cost portfolio formed by sorting stocks based on their market value of equity generates a significant return of -1.16% per month with a tstatistic of -2.36 in Asia, no such pattern exists for the other regions. The book-to-market effect seems to be driven by equities in the Latin America and Africa regions. The momentum effect is robust across Europe, Asia and Africa with statistically significant monthly zero-cost portfolio returns of 2.18%, 2.06% and 2.48%, respectively. Table 3 also revealed that the shortterm reversal and lottery demand anomalies produced returns with opposite signs to those expected from U.S. studies in the overall sample. We find that both results are driven mostly by Asian and Latin American countries. The zero-cost portfolio strategy based on STR produces returns of 1.26% and 2.06% with t-statistics of 2.09 and 2.57 in Asia and Latin America, respectively. The zero-cost portfolio strategy based on MAX1 produces returns of 1.20% and 3.06% with t-statistics of 2.00 and 2.99 in Asia and Latin America, respectively.
Although we did not find significant relations between the other firm-specific attributes and future equity returns in our overall emerging market sample, it is possible to observe some predictive power associated with these attributes when we focus on individual regions. First, we find a significantly positive relation between market beta and one-month-ahead equity returns in Europe with a return of 1.59% (t-statistic = 2.08) to the zero-cost portfolio and significant alphas. Second, we find that the illiquidity measure based on non-trading days has a significantly negative relation with one-month-ahead returns in all regions except Africa and IVOL has a significantly positive relation with one-month-ahead returns in Latin America. Third, zero-cost portfolio strategies based on all three stock-specific left-tail risk measures produce significantly positive returns and alphas between 1.21% and 2.27% in Europe. A similar relation is observed in Latin America when LPM is used as the stock-specific left-tail risk measure. Finally, we find that hybrid tail risk is negatively priced in Europe and Latin America.
These results speak to the importance of accounting for regional differences in the patterns pertaining to the cross-section of equity returns."
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Two new strategies have been added:
#400 – Accruals Effect Combined with Price Momentum
#401 – Carry On – Enhanced Carry Strategy
One new related research paper has been included into existing strategy reviews. And two additional related research papers have been included into existing free strategy reviews during last few weeks.
Authors: Blitz, Vidojevic
Title: The Characteristics of Factor Investing
Link: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3206798
Abstract:
We dissect the performance of factor-based equity portfolios using a characteristics-based multi-factor expected return model. We show that generic single-factor portfolios, which invest in stocks with high scores on one particular factor, are sub-optimal, because they ignore the possibility that these stocks may be unattractive from the perspective of other factors. We also show that differences in performance between (i) integrated and mixed-sleeve multi-factor portfolios, (ii) small-cap and large-cap factor portfolios, and (iii) equal and value-weighted factor portfolios can be fully attributed to the differences in their factor characteristics. We conclude that efficient factor investing requires a recognition and understanding of how factor characteristics drive portfolio returns.
Notable quotations from the academic research paper:
"We show that generic single-factor portfolios, which are strategies that invest in stocks which score highly on one particular factor are generally sub-optimal, because they ignore the possibility that these stocks may be unattractive from the perspective of other factors. The negative contributions from other factors cause these strategies to have a substantial weight in stocks with negative expected and ex-post realized market-relative returns. We also show that some stocks have such poor factor characteristics that their expected returns end up being lower than returns on Treasuries. By simply removing those stocks from the market portfolio ex-ante, the realized market return increases by 16%, in relative terms, over the sample period that spans more than five decades.
We examine what happens to performance if, each month, we simply remove stocks that have a negative predicted market-relative return from generic factor portfolios. The performance of such enhanced factor strategies is shown in Figure 6. Compared to the generic factor strategies from which they are derived, the performance improvements are about 20% for the value, momentum and investment strategies and about 50% for the small-cap strategy. For the profitability strategy, performance more than triples, from 0.08% to 0.29% per month. This large improvement is not surprising, because a much bigger adjustment is made to this portfolio than to the other factor portfolios. These results imply that generic factor strategies are sub-optimal, and that, even when targeting one particular factor premium, investors should not ignore other established factor premiums.
Excluding stocks with expected underperformance helps to enhance a single-factor strategy, but the resulting portfolios can still have stocks with negative exposures to other factors that detract from their performance. We next examine how performance changes if in addition to removing stocks with expected underperformance, we also require stocks to have a non-negative exposure (z-score) to at least one, two, three or four other, non-targeted premiums. Figure 7 shows that realized, full-sample returns of each single factor strategy tend to increase as we require stocks in the portfolios to have non-negative exposures to more factors. For instance, our raw value strategy has a return of 0.23% a month, which increases to 0.28% per month if we ex-ante exclude stocks with negative expected excess returns. If in addition, at the time of portfolio formation, we require that stocks have non-negative exposures to at least two, three, four, and all five factor premiums, the strategy returns increase to 0.30%, 0.37%, 0.54%, and 0.69%, respectively. The number of stocks in the portfolio decreases as we impose more constraints from, on average, 302 with no constraints to 276, 273, 223, 96, and only 13. A similar pattern is observed for other factors, albeit not always monotonic.
Our model is also able to attribute performance differences between integrated and mixed-sleeve multi-factor portfolios to differences in their factor characteristics, and thus resolve the heated discussion in the literature over which approach is better for construction of portfolios with exposures to multiple factors. We further show that return differences between factor portfolios in the small-cap and the large-cap space, and between equally-weighted and value-weighted factor portfolios can also be explained by our model."
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Authors: Yang
Title: Behavioral Anomalies in Cryptocurrency Markets
Link: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3174421
Abstract:
If behavioral biases explain asset pricing anomalies, they should also materialize in cryptocurrency markets. I test more than 20 stock return anomalies based on daily cryptocurrency data, and document strong evidence of price momentum. Unlike stock markets, price reversal and risk-based anomalies are weak, controlling for market and size. Cryptocurrency anomalies can be explained by behavioral theories that place more emphasis on the role of speculators than fundamental traders.
Notable quotations from the academic research paper:
"The speculative and hard-to-value nature makes the cryptocurrency market a novel environment that facilitates the study of behavioral impacts on asset prices. Because speculators account for the vast majority of cryptocurrency market participants, the behavioral impact can be stronger than traditional markets. Aside from this, cryptocurrency markets enjoy some good properties: the overall level of investor sophistication in cryptocurrency markets are much lower; there are only a few institutional investors until recently. Thus, mispricing can be severe. Above stylized facts of cryptocurrency markets fit well into many behavioral theories that particularly emphasize investor irrationality. Thus, if asset pricing anomalies can be explained by behavioral theories, they shall also be reflected in cryptocurrency markets.
Having this in mind, I test more than 20 stock price anomalies based on cryptocurrency data.
Interestingly, anomalies that are commonly recognized as behavior-driven, in particular, price momentum, are also observed in cryptocurrency markets. Price momentum describes the phenomenon that past winner (loser) assets may continue to outperform (underperform) in the future. The momentum effect turns out statistically significant and robust in various aspects. In contrast, risk-based anomalies, for example, return moment risks, are insignificant. The results are not surprising, as if the incentive for holding cryptocurrencies is largely speculative, it is not expected that exposure to certain form of risk earns a premium.
Unlike stock markets, short-term price reversal in cryptocurrency markets is very weak at a daily frequency. No evidence of long-term price reversal is revealed. This empirical finding makes cryptocurrency anomalies distinct from stock market anomalies.
The most plausible explanation of cryptocurrency momentum is given by De Long, Shleifer, Summers, and Waldmann (1990). Their model implies that overconfident noise traders push up the price and create risk that makes fundamental traders reluctant to combat mispricing. If noise traders dominate, overpricing can be even more severe, as is the case of cryptocurrency markets, where speculators play the role of overconfident noise traders. Further, their model does not predict a long-term reversal as long as noise traders remain overconfident. This situation is analogous to cryptocurreny markets and consistent with the empirical findings of this paper. Moreover, their model implies an excessive volatility, another empirical stylized fact of cryptocurrency markets."
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